CHESAPEAKE ENERGY CORP CHK
October 07, 2011 - 12:34pm EST by
ncs590
2011 2012
Price: 25.91 EPS $2.80 $2.86
Shares Out. (in M): 660 P/E 9.2x 9.0x
Market Cap (in M): 17,122 P/FCF 0.0x 0.0x
Net Debt (in M): 11,700 EBIT 0 0
TEV: 31,887 TEV/EBIT 0.0x 0.0x

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Description

I am recommending a long position in Chesapeake Energy. Chesapeake is the second largest producer of natural gas with one of the lowest cost structures in North America and is rapidly becoming a major producer of oil and natural gas liquids. I think the stock is currently undervalued in the short term due to uncertainty regarding their Utica shale joint venture, and due to underfunded future capex plans (which the aforementioned joint venture would solve).

In the longer term, there are other reasons that this company is undervalued. The market takes a dim view of the company's management and corporate governance, and many investors think the company is too complex to value due to the amount of non-producing assets, financial engineering, and corporate complexity. I will discuss these issues and take a stab at coming up with a firm conservative valuation below. Questions are more than welcome, thanks.


Chesapeake Management:

BEARISH VIEW:

• Aubrey McClendon and Tom Ward nearly bankrupted CHK in the late 90s by levering up the company to build a huge position in what turned out to be "non-core" Austin Chalk before prices collapsed for a number of years.
• McClendon lost about $2 Billion personally in 2008, after margining his 30MM share CHK equity position to buy millions more in CHK stock at prices as high as $57.25.
• The highly compensated ($400k + per annum) and management friendly board of directors paid McClendon $100 million dollars in what amounted to a personal bailout of their Chairman in 2008. The company also elected to buy $12 million dollars of antique maps from McClendon, which decorate company headquarters.
• Management has declared on numerous occasions that they were done raising capital and buying assets, only to raise billions in capital and expand first into the Haynesville shale and then recently into numerous oil/liquids shale plays.
• Chesapeake may have expanded beyond their core competency (of producing low cost natural gas) into "lease brokering", an aggressive hedge program that can only be called energy trading, and most recently into oil/liquids production.

MY TAKE:

His supporters will say - and we think history will show - that Aubrey McClendon is a visionary. He seems to have learned his lesson with regard to "non-core" acreage in the Austin Chalk, and has created the #1 or #2 "core" leasehold positions in the five largest gas shales and four of the five largest oil shales in the US - all at very attractive prices. This was accomplished by running the most "information only" rigs, building the largest geophysical reservoir evaluation lab, having the most landmen, and having a willingness to move quickly.

Aubrey McClendon is regarded by many in the investor community as reckless, willing to expand at any cost, and unwilling to be left behind. Analysts I've spoken to don't doubt the value of the assets McClendon has put together, but there is a widespread fear that he will keep "creating value" until it bankrupts the company. Chesapeake expanded aggressively into the Barnett, Marcellus (partially through a fortuitous acquisition of CNR), Fayetteville, Haynesville, Eagle Ford and Niobrara shales. Each time this happened, there were concerns that the company had spent too much money on land and would have a liquidity problem.

In each play, CHK was able to sell a fractional JV interest for a multiple of what they paid - essentially recouping their entire investment for both the portion they sold and the majority they kept. Each time this has happened, detractors have chalked it up to luck and suggested that the acquirer foolishly overpaid. Considering that the acquirers were BP, Total, Statoil, CNOOC, and PXP, this is very unlikely (except perhaps in the Haynesville, which PXP bought into at the top of the market). Despite this 6/6 record of wildly accretive billion dollar JV deals; the market currently doubts whether CHK can do it again with their recently acquired Utica acreage.

To understand whether CHK has just been lucky or actually has some advantage in acquiring land, one can look at their recent Eagle Ford JV. In late 2009 and early 2010, they drilled and cored ten vertical wells and acquired 830 square miles of 3D seismic. At Chesapeake's reservoir technology center - which analyses more shale core than the rest of the industry combined - they delineated the area of the "oil window" up-dip as well as the area where the formation was thickest within this window. They identified and avoided the Western section, where despite some of the thickest shale the oil was too immature and viscous to be productive. After fracture simulations at the technology center and actual test wells confirmed the economics of the play, CHK was able to rapidly lease 600,000 acres in the thickest part of the mature oil window for a total cost of $1.4 billion. Within twelve months, CHK was able to sell a 33% stake to CNOOC for $2.16 billion, with half up front and the rest payable over two years as a drilling carry.

If one uses a present value for the 33% stake purchased by CNOOC of $2 Billion (using a 10% discount rate), that means CHK spent $1.4 billion and turned it into $6 billion of value in just one year - a third of which in cash to immediately recoup their investment. This was not reckless and it was not lucky - Chesapeake was able to turn their temporary informational advantage into a permanent structural advantage; 400,000 net acres in the best part of the play at a negative net cost to the company (after the CNOOC deal). A number of large recent transactions in the Eagle Ford have been completed at prices of more than $20,000 per acre, which would value CHK's 400,000 net acres at $8 Billion dollars (the company actually has 450,000 net acres now due to additional leases signed after the JV deal so this number is higher). To put this in perspective, this is more than $10 per fully diluted share for this one asset, and the net cost to Chesapeake was negative.

Chesapeake runs 15 "information only" drilling rigs - more than most public E&Ps have for production. This company has consistently been able to gain an informational advantage, not only in finding plays, but in delineating the extent and "core" or sweat-spot of plays others have discovered. By leasing the best acreage, they have consistently turned a 6-month information advantage into a permanent cost-advantage. The company has signaled that this land rush is now essentially over and they have already seen core samples of every depositional basin in the country.

Chesapeake's management has been creative in raising capital; pioneering the large scale use of VPPs for financing, courting Asian SWFs for capital, and doing the first US oil and gas deal with a Chinese company. Chesapeake is completely vertically integrated, the most active driller, the largest owner of onshore US seismic data, and the largest customer to the service industry. These are major advantages in both producing and discovering gas, and probably also gives them an advantage in their hedging program (which has generated $7.7 billion in realized gains from 2001-2011).

McClendon may change the direction of the ship more often than investors would like, but his moves have been correct and created value. His bold expansions have been a capitalization on CHK's informational and technological advantages, not the shoot-from-the-hip moves of a manic empire builder. He was right on the gas shales, and is being proven right on the oil shales. Every major expansion McClendon has undertaken has generated a multiple of the expenditure in value to the company. This value is not reflected in the stock, but it is easily verifiable (and will be delineated in the valuation section). The investment community apparently believes McClendon and his team were wrong to create this value because the share price hasn't gone up yet.

I disagree with those who want Chesapeake to stop doing large and highly accretive land deals, but it looks like that crowd will get their wish in 2012. There are only so many depositional basins in the United States, and at this point, E&P companies have gotten a look at all of them. There is no chance of finding another shale play in Nevada, for instance - shale is the source rock for conventional oil and gas pools, and it only exists where there has been conventional production for years. There could be another large discovery in an existing basin, but it is increasingly unlikely.

Both McClendon and his (essentially captive) board are very well compensated, but it is not as egregious as the headlines suggest. His "$100 million payday" was really $75 million payable over five years (with no other bonus during this time). He is still very highly compensated and gets a lot of perks, but so do a lot of people at Goldman Sachs - and none of them made a $4 billion gain on one deal for the company in 2010 like McClendon did. While the $12 million purchase of the maps was egregious, it focused shareholders and the media on the poor corporate governance at Chesapeake, which has improved now that the board is under a spotlight. This company is promotional and controversial, and investors need to make a judgment as to whether Aubrey is smart and aggressive or just crazy - the track record of consistently successful value creation suggests the former.

In January of this year, Lou Simpson, of Berkshire Hathaway and Geico fame joined the board of directors. I view this as a very positive move from a corporate governance standpoint and a vote of confidence in the integrity of management. In August, Mr. Simpson purchased 100,000 shares in the open market at an average price of $27.46.

I think that the majority of corporate governance issues have been addressed. As to whether management's bold and unapologetic style is something to be concerned about, I think an investor has to look at the track record of what they have accomplished rather than a collection of minor public relations gaffes. If the skill of an investor is ultimately judged by his long term track record, then Aubrey McClendon is one of the greats. The last ten years of hedging, acquisitions, and divestitures has been nearly flawless. Despite a crash in natural gas prices and some minor forays into shale plays that didn't work out (the company wasted about $350 million leasing in Michigan), this company is batting around .800, and has been doing so for years.

By the end of this year Chesapeake will JV a portion of their newly acquired Utica shale asset in Eastern Ohio. The market did not react well when the company announced a year ago that they planned to spend $1 billion on this - then unnamed - "liquids" shale play. Since then they have spent a total of $1.5 billion, and have announced that they will sell an interest in it by the end of this year. The company says their acreage is worth $15-20 billion. This is a very large number, but the company has a perfect track record at selling joint venture deals within both the timeframe and valuation range they have announced beforehand. If they sell just 25% of the play at a valuation of $15 billion, they will have taken care of any future capex shortfalls and retained an asset worth more than $11 billion dollars at a negative net cost to the company. It is worth noting that Exxon recently bought into this play (buying private Phillips exploration) at a reported $10,000 per acre, which suggests CHK's acreage is worth $12.5 billion - and this was without seeing the results of Chesapeake's wells.


Financing

BEARISH VIEW:

• Chesapeake is one of the most highly levered players in the space, and consistently outspends cash flow.
• While the company has been successful is selling assets in order to make up the shortfall over the last few years, it is unclear if they will be able to do so going forward, potentially causing a liquidity problem which could lead to dilution.
• Chesapeake has sold volumetric production payments (VPP) to financial players, getting cash up front for gas to be delivered in the future. This is considered by some to be a form of off-balance sheet debt.


MY TAKE:

Chesapeake has been extremely creative in financing their growth. While they have $9.7 billion in debt, they pay a blended rate of only 5.8% and have an average maturity of seven years. They termed out their revolver to 2015 and expanded the capacity from $3.5 billion to $4 billion (with the option to expand to $5 billion).

The VPP deals are definitely not debt, off balance sheet or not. In these deals, Chesapeake has sold an overriding royalty on certain mature producing wells in a given area for a certain amount of time. The volume they sell is about 80% of what the wells are expected to produce during that timeframe, and while ownership of the wells reverts to Chesapeake after the VPP term, due to decline rates and the time value of money, there is little value left. If these wells blow-up, sand-up, or otherwise disappear, Chesapeake has no further liability. The only liability the company retains is their 20% interest; in the unlikely event that the wells do not produce as much gas as expected, the difference comes out of Chesapeake's remaining 20% interest in the production from that well group - but this is specific to a group of wells, not an area, subsidiary, or any other entity. There is no liability to CHK, other than the potential to give a little more gas out of a given underperforming group of wells, up to but not beyond the ownership interest CHK retains in that group.

As with the recent Eagle Ford and Niobrara joint ventures, the investment community seems to think that Chesapeake will not be able to get a joint venture done in the Utica and thus will be unable to fund its (discretionary) capex next year, and thus will dilute shareholders. Every piece of evidence, not to mention their track record, suggests otherwise. The company is also planning to sell a royalty trust in their granite wash play for $500 million, will sell more midstream assets into their publicly traded midstream subsidiary, will divest some portion of their 1.1 million acre Mississipian lime play in 2012 and plans to IPO their service business sometime next year (which will likely net them $1.5 billion).

The bottom line is that investors have been concerned about CHK's ability to fund its expansion for years, and they have always found an intelligent way to do it. There is no chance that CHK won't be able to fund their discretionary spending plans, just a small danger that they will have to go to the capital markets if they somehow can't raise money elsewhere (JV's, VPPs, and midstream MLPs being preferable and much more likely). In addition to the planned monetizations above, they could sell a further interest in the Marcellus shale to Statoil or sell a portion of their huge Permian basin position. Judging from the unbelievable returns on the Eagle Ford investment, it is unlikely that the net result of any major expenditure currently occurring will be dilutive, regardless of the funding source.

 

Valuation:

BEARISH VIEW:

• At current rates of drilling, Chesapeake has 40-60 years worth of inventory in their major shale plays, suggesting that the PV10 value of most of this acreage is negligible.
• Natural gas prices have fallen since CHK signed major JV deals in the Haynesville and Fayetteville shale plays, suggesting that their partners overpaid and that this acreage is not worth the price implied by these deals.
• Chesapeake assumes well lives of up to 65 years in calculating estimated ultimate recoveries (EUR) for its wells, potentially understating their finding and developing cost of these wells (for which there is less than a decade of historical data) decline at a greater than expected rate.
• Some of Chesapeake's acreage may not be "core" or even have any value, particularly their Marcellus acreage in New York (where there is currently a drilling moratorium) and in Central West Virginia.


MY TAKE:

In the last two years, numerous comparable transactions by Chesapeake and others have put firm values on the majority of their assets. Chesapeake puts out a monthly presentation which shows all of their plays which may be helpful to look at in conjunction with the below.

http://www.chk.com/Investors/Documents/Latest_IR_Presentation.pdf

Like everyone else, I ignore what Chesapeake says their assets are worth, but I have found good public comps for most and have discounted the values of other assets in a conservative manner:

Chesapeake sold 25% of their Barnett shale operation to Total two years ago (after gas prices had already crashed) for $2.25 billion. After discounting the cash flows received from Total (not all up front) and subtracting the $1.15 billion price of a VPP they subsequently sold in the play, CHK's interest is valued at $5.2 billion. While this play is not their most economic, the large amount of current production there drives the value.

In the Eagle Ford Shale, Marathon paid $3.5 billion or nearly $25,000 per acre to buy out Hilcorp in June. BHP is purchasing Petrohawk for $15 billion, which yields similar metrics but not an exact figure because Petrohawk had other assets. At $20,000 an acre Chesapeake's 450,000 acres is worth $9 billion.

Chesapeake has drilling carries (future payments as part of past joint ventures) due to it from Total, Statoil and CNOOC with a present value of $2.6 billion. The company also owns 34.6% of its publicly traded midstream company (CHKM) worth $1.3 billion.

In the "Niobrara" (now called Powder River and DJ Basin), Chesapeake sold 1/3 of their position to CNOOC this year for a discounted value of $4,200 per acre. There is less information available on this play or good comps from shrewd acquirers (CNOOC doesn't get a lot of respect on the street), so I value the remaining interest in this play at half of that price, or $1.25 billion.

In the Mississippian lime Chesapeake has 1.1 million acres. Sandridge Energy sold a royalty trust (essentially a publicly traded JV interest because the royalties will come on wells that have yet to be drilled) which valued this play at $15,000 per acre. I think the value is currently closer to $5,000 per acre, but without public comps to look at I will use half of this value and say it is worth $2,500 an acre. I also assume not all of CHK's land is "core", so I will assume they only have 800,000 rather than 1.1 million acres. This yields a value for the Mississippian of $2 billion.

Looking at their property plant and equipment, Chesapeake owns one of the largest drilling contractors, service companies, compression companies, oilfield trucking companies etc. Both Frac Tech (their 30% owned completion company) and the newly defined Chesapeake Oilfield Services are likely to be IPO'd next year at a total value of $7 - 10 billion according to the company. This segment will do $1 billion in EBITDA next year, and comps currently trade at the low end of the range given by Chesapeake (HP trades at 6 times EBITDA, HAL at 7.5 times, EXH at 6.5 times). I value this entire segment at only $1.5 billion because that is what I estimate Chesapeake will actually raise in cash from IPO'ing these companies.

Chesapeake has a huge amount of legacy production in the Permian, Appalachian, and Anadarko Basins. I value this at proved-only PV10 value (the discounted value of future cash flows from the proved reserves on these properties) of $13 billion from the last time Chesapeake broke out this value in 2010. I think this is pretty conservative because it ascribes no value to the huge undrilled inventory in the Permian, Granite Wash, and Cleveland plays - all of which are oily. Chesapeake has 835,000 acres in the Permian alone, which is probably worth $15,000 per acre based on comparable transaction (which would value this one portion at $12.5 billion).

This leaves the Marcellus and Haynesville shale plays, which are tougher to value. I previously modeled wells in the Marcellus, Haynesville and Fayetteville shale plays using ten year gas strip prices, known well "type curves", and the next ten years of drilling based on planned rig counts in each play. I assumed wells dried up completely after ten years (there is some controversy over projected 45-65 year well lives), and that drilling ceased after ten years. I assumed 40% of the acreage in each play was worthless and that the undrilled portion of the remaining play was worth only the lowest comparable transaction price. I also discounted the value of current production in each play and got a total value for the Marcellus of $11.7 billion, for the Haynesville of $4 billion (nearly $1.5 of this from current production) and for the Fayetteville of $1.5 billion ($1 billion from production).

After I modeled this about a year ago, BHP bought the Fayetteville asset for $4.75 billion (I assume $500 million of this was for midstream assets - but still more than double my value), so I feel pretty confident that my approach is conservative. Results in the Marcellus have improved since then and Exxon is actively leasing in the Haynesville.

Range Resources is basically a pure play on the Marcellus, so there is a good comp here. If one (generously) values RRC's Permian acreage at $15,000 per acre, and their Anadarko acreage at $5,000 per acre, the market is valuing their 800k acres in the Marcellus at over $10 billion today, or $12,500 per acre. I think this is reasonable, and if I apply this metric to just 60% of CHK's 1.75 million acres in the Marcellus I get a value of $13.1 billion.

BHP's $15 billion purchase of Petrohawk this year almost certainly valued the Haynesville shale at more than double my valuation (or the Eagle Ford much higher), so I feel very comfortable valuation CHK's Marcellus at $12 billion and the Haynesville shale at $4 billion.

The last major asset is the Utica Shale. I believe all of the circumstantial and geophysical evidence suggest that this will be worth the $15-20 billion the company says it will. This joint venture will likely occur in the next month or two and place a firm value on the remaining acreage. For now I will value their 1.25 million acres at the $10,000 figure XOM reportedly paid for Phillips, or $12.5 billion.

There are other assets that could be added, but I think this is a very conservative and firm valuation of the company's assets. Essentially I think they could sell any of these assets tomorrow for the price I give without any problem or disruption to their business (which is why I value the service company etc. only at the cash they will extract from it).

The total (in $ billions):

Barnett shale: $5.2
Eagle Ford shale: $9
Drilling carries: $2.6
CHKM ownership: $1.3
"Niobrara": $1.25
Mississipian: $2
Service companies: $1.5
Permian and Anadarko PV10: $13
Marcellus shale: $12
Haynesville shale: $4
Utica shale: $12.5

Debt and negative working capital: -$12

Equity Value: $52.35 billion

At this valuation, the convertible preferreds would convert to equity so I use a fully diluted share count of 765 million shares, for a value per share of $68.43.

I think the breakup value of the company is probably significantly higher than this, and that the ultimate value (when natural gas recovers in 2012/2013 - which is much longer topic than this write-up) is certainly in triple digits.

Conclusion:

Six times Chesapeake has been criticized for spending too much on land, and six times they have avoided any funding crisis and successfully recouped their investment with a JV, within the timeframe and valuation McClendon claimed. This record will be tested in the next month or two with the Utica joint venture, but history would suggest that the most active driller, with the best information, and a track record of doing identical deals on a similar scale with 100% success knows what they were buying this time around too. Even without these deals, the company is not currently facing a funding crisis, so there is little justification for their huge undervaluation compared to peers, and large market transactions by the oil majors.

The Author, his family, and clients are long CHK equity, preferred stock, and call options

 I am recommending a long position in Chesapeake Energy. Chesapeake is the second largest producer of natural gas with one of the lowest cost structures in North America and is rapidly becoming a major producer of oil and natural gas liquids. I think the stock is currently undervalued in the short term due to uncertainty regarding their Utica shale joint venture, and due to underfunded future capex plans (which the aforementioned joint venture would solve).

In the longer term, there are other reasons that this company is undervalued. The market takes a dim view of the company's management and corporate governance, and many investors think the company is too complex to value due to the amount of non-producing assets, financial engineering, and corporate complexity. I will discuss these issues and take a stab at coming up with a firm conservative valuation below. Questions are more than welcome, thanks.


Chesapeake Management:

BEARISH VIEW:

• Aubrey McClendon and Tom Ward nearly bankrupted CHK in the late 90s by levering up the company to build a huge position in what turned out to be "non-core" Austin Chalk before prices collapsed for a number of years.
• McClendon lost about $2 Billion personally in 2008, after margining his 30MM share CHK equity position to buy millions more in CHK stock at prices as high as $57.25.
• The highly compensated ($400k + per annum) and management friendly board of directors paid McClendon $100 million dollars in what amounted to a personal bailout of their Chairman in 2008. The company also elected to buy $12 million dollars of antique maps from McClendon, which decorate company headquarters.
• Management has declared on numerous occasions that they were done raising capital and buying assets, only to raise billions in capital and expand first into the Haynesville shale and then recently into numerous oil/liquids shale plays.
• Chesapeake may have expanded beyond their core competency (of producing low cost natural gas) into "lease brokering", an aggressive hedge program that can only be called energy trading, and most recently into oil/liquids production.

MY TAKE:

His supporters will say - and we think history will show - that Aubrey McClendon is a visionary. He seems to have learned his lesson with regard to "non-core" acreage in the Austin Chalk, and has created the #1 or #2 "core" leasehold positions in the five largest gas shales and four of the five largest oil shales in the US - all at very attractive prices. This was accomplished by running the most "information only" rigs, building the largest geophysical reservoir evaluation lab, having the most landmen, and having a willingness to move quickly.

Aubrey McClendon is regarded by many in the investor community as reckless, willing to expand at any cost, and unwilling to be left behind. Analysts I've spoken to don't doubt the value of the assets McClendon has put together, but there is a widespread fear that he will keep "creating value" until it bankrupts the company. Chesapeake expanded aggressively into the Barnett, Marcellus (partially through a fortuitous acquisition of CNR), Fayetteville, Haynesville, Eagle Ford and Niobrara shales. Each time this happened, there were concerns that the company had spent too much money on land and would have a liquidity problem.

In each play, CHK was able to sell a fractional JV interest for a multiple of what they paid - essentially recouping their entire investment for both the portion they sold and the majority they kept. Each time this has happened, detractors have chalked it up to luck and suggested that the acquirer foolishly overpaid. Considering that the acquirers were BP, Total, Statoil, CNOOC, and PXP, this is very unlikely (except perhaps in the Haynesville, which PXP bought into at the top of the market). Despite this 6/6 record of wildly accretive billion dollar JV deals; the market currently doubts whether CHK can do it again with their recently acquired Utica acreage.

To understand whether CHK has just been lucky or actually has some advantage in acquiring land, one can look at their recent Eagle Ford JV. In late 2009 and early 2010, they drilled and cored ten vertical wells and acquired 830 square miles of 3D seismic. At Chesapeake's reservoir technology center - which analyses more shale core than the rest of the industry combined - they delineated the area of the "oil window" up-dip as well as the area where the formation was thickest within this window. They identified and avoided the Western section, where despite some of the thickest shale the oil was too immature and viscous to be productive. After fracture simulations at the technology center and actual test wells confirmed the economics of the play, CHK was able to rapidly lease 600,000 acres in the thickest part of the mature oil window for a total cost of $1.4 billion. Within twelve months, CHK was able to sell a 33% stake to CNOOC for $2.16 billion, with half up front and the rest payable over two years as a drilling carry.

If one uses a present value for the 33% stake purchased by CNOOC of $2 Billion (using a 10% discount rate), that means CHK spent $1.4 billion and turned it into $6 billion of value in just one year - a third of which in cash to immediately recoup their investment. This was not reckless and it was not lucky - Chesapeake was able to turn their temporary informational advantage into a permanent structural advantage; 400,000 net acres in the best part of the play at a negative net cost to the company (after the CNOOC deal). A number of large recent transactions in the Eagle Ford have been completed at prices of more than $20,000 per acre, which would value CHK's 400,000 net acres at $8 Billion dollars (the company actually has 450,000 net acres now due to additional leases signed after the JV deal so this number is higher). To put this in perspective, this is more than $10 per fully diluted share for this one asset, and the net cost to Chesapeake was negative.

Chesapeake runs 15 "information only" drilling rigs - more than most public E&Ps have for production. This company has consistently been able to gain an informational advantage, not only in finding plays, but in delineating the extent and "core" or sweat-spot of plays others have discovered. By leasing the best acreage, they have consistently turned a 6-month information advantage into a permanent cost-advantage. The company has signaled that this land rush is now essentially over and they have already seen core samples of every depositional basin in the country.

Chesapeake's management has been creative in raising capital; pioneering the large scale use of VPPs for financing, courting Asian SWFs for capital, and doing the first US oil and gas deal with a Chinese company. Chesapeake is completely vertically integrated, the most active driller, the largest owner of onshore US seismic data, and the largest customer to the service industry. These are major advantages in both producing and discovering gas, and probably also gives them an advantage in their hedging program (which has generated $7.7 billion in realized gains from 2001-2011).

McClendon may change the direction of the ship more often than investors would like, but his moves have been correct and created value. His bold expansions have been a capitalization on CHK's informational and technological advantages, not the shoot-from-the-hip moves of a manic empire builder. He was right on the gas shales, and is being proven right on the oil shales. Every major expansion McClendon has undertaken has generated a multiple of the expenditure in value to the company. This value is not reflected in the stock, but it is easily verifiable (and will be delineated in the valuation section). The investment community apparently believes McClendon and his team were wrong to create this value because the share price hasn't gone up yet.

I disagree with those who want Chesapeake to stop doing large and highly accretive land deals, but it looks like that crowd will get their wish in 2012. There are only so many depositional basins in the United States, and at this point, E&P companies have gotten a look at all of them. There is no chance of finding another shale play in Nevada, for instance - shale is the source rock for conventional oil and gas pools, and it only exists where there has been conventional production for years. There could be another large discovery in an existing basin, but it is increasingly unlikely.

Both McClendon and his (essentially captive) board are very well compensated, but it is not as egregious as the headlines suggest. His "$100 million payday" was really $75 million payable over five years (with no other bonus during this time). He is still very highly compensated and gets a lot of perks, but so do a lot of people at Goldman Sachs - and none of them made a $4 billion gain on one deal for the company in 2010 like McClendon did. While the $12 million purchase of the maps was egregious, it focused shareholders and the media on the poor corporate governance at Chesapeake, which has improved now that the board is under a spotlight. This company is promotional and controversial, and investors need to make a judgment as to whether Aubrey is smart and aggressive or just crazy - the track record of consistently successful value creation suggests the former.

In January of this year, Lou Simpson, of Berkshire Hathaway and Geico fame joined the board of directors. I view this as a very positive move from a corporate governance standpoint and a vote of confidence in the integrity of management. In August, Mr. Simpson purchased 100,000 shares in the open market at an average price of $27.46.

I think that the majority of corporate governance issues have been addressed. As to whether management's bold and unapologetic style is something to be concerned about, I think an investor has to look at the track record of what they have accomplished rather than a collection of minor public relations gaffes. If the skill of an investor is ultimately judged by his long term track record, then Aubrey McClendon is one of the greats. The last ten years of hedging, acquisitions, and divestitures has been nearly flawless. Despite a crash in natural gas prices and some minor forays into shale plays that didn't work out (the company wasted about $350 million leasing in Michigan), this company is batting around .800, and has been doing so for years.

By the end of this year Chesapeake will JV a portion of their newly acquired Utica shale asset in Eastern Ohio. The market did not react well when the company announced a year ago that they planned to spend $1 billion on this - then unnamed - "liquids" shale play. Since then they have spent a total of $1.5 billion, and have announced that they will sell an interest in it by the end of this year. The company says their acreage is worth $15-20 billion. This is a very large number, but the company has a perfect track record at selling joint venture deals within both the timeframe and valuation range they have announced beforehand. If they sell just 25% of the play at a valuation of $15 billion, they will have taken care of any future capex shortfalls and retained an asset worth more than $11 billion dollars at a negative net cost to the company. It is worth noting that Exxon recently bought into this play (buying private Phillips exploration) at a reported $10,000 per acre, which suggests CHK's acreage is worth $12.5 billion - and this was without seeing the results of Chesapeake's wells.


Financing

BEARISH VIEW:

• Chesapeake is one of the most highly levered players in the space, and consistently outspends cash flow.
• While the company has been successful is selling assets in order to make up the shortfall over the last few years, it is unclear if they will be able to do so going forward, potentially causing a liquidity problem which could lead to dilution.
• Chesapeake has sold volumetric production payments (VPP) to financial players, getting cash up front for gas to be delivered in the future. This is considered by some to be a form of off-balance sheet debt.


MY TAKE:

Chesapeake has been extremely creative in financing their growth. While they have $9.7 billion in debt, they pay a blended rate of only 5.8% and have an average maturity of seven years. They termed out their revolver to 2015 and expanded the capacity from $3.5 billion to $4 billion (with the option to expand to $5 billion).

The VPP deals are definitely not debt, off balance sheet or not. In these deals, Chesapeake has sold an overriding royalty on certain mature producing wells in a given area for a certain amount of time. The volume they sell is about 80% of what the wells are expected to produce during that timeframe, and while ownership of the wells reverts to Chesapeake after the VPP term, due to decline rates and the time value of money, there is little value left. If these wells blow-up, sand-up, or otherwise disappear, Chesapeake has no further liability. The only liability the company retains is their 20% interest; in the unlikely event that the wells do not produce as much gas as expected, the difference comes out of Chesapeake's remaining 20% interest in the production from that well group - but this is specific to a group of wells, not an area, subsidiary, or any other entity. There is no liability to CHK, other than the potential to give a little more gas out of a given underperforming group of wells, up to but not beyond the ownership interest CHK retains in that group.

As with the recent Eagle Ford and Niobrara joint ventures, the investment community seems to think that Chesapeake will not be able to get a joint venture done in the Utica and thus will be unable to fund its (discretionary) capex next year, and thus will dilute shareholders. Every piece of evidence, not to mention their track record, suggests otherwise. The company is also planning to sell a royalty trust in their granite wash play for $500 million, will sell more midstream assets into their publicly traded midstream subsidiary, will divest some portion of their 1.1 million acre Mississipian lime play in 2012 and plans to IPO their service business sometime next year (which will likely net them $1.5 billion).

The bottom line is that investors have been concerned about CHK's ability to fund its expansion for years, and they have always found an intelligent way to do it. There is no chance that CHK won't be able to fund their discretionary spending plans, just a small danger that they will have to go to the capital markets if they somehow can't raise money elsewhere (JV's, VPPs, and midstream MLPs being preferable and much more likely). In addition to the planned monetizations above, they could sell a further interest in the Marcellus shale to Statoil or sell a portion of their huge Permian basin position. Judging from the unbelievable returns on the Eagle Ford investment, it is unlikely that the net result of any major expenditure currently occurring will be dilutive, regardless of the funding source.

 

Valuation:

BEARISH VIEW:

• At current rates of drilling, Chesapeake has 40-60 years worth of inventory in their major shale plays, suggesting that the PV10 value of most of this acreage is negligible.
• Natural gas prices have fallen since CHK signed major JV deals in the Haynesville and Fayetteville shale plays, suggesting that their partners overpaid and that this acreage is not worth the price implied by these deals.
• Chesapeake assumes well lives of up to 65 years in calculating estimated ultimate recoveries (EUR) for its wells, potentially understating their finding and developing cost of these wells (for which there is less than a decade of historical data) decline at a greater than expected rate.
• Some of Chesapeake's acreage may not be "core" or even have any value, particularly their Marcellus acreage in New York (where there is currently a drilling moratorium) and in Central West Virginia.


MY TAKE:

In the last two years, numerous comparable transactions by Chesapeake and others have put firm values on the majority of their assets. Chesapeake puts out a monthly presentation which shows all of their plays which may be helpful to look at in conjunction with the below.

http://www.chk.com/Investors/Documents/Latest_IR_Presentation.pdf

Like everyone else, I ignore what Chesapeake says their assets are worth, but I have found good public comps for most and have discounted the values of other assets in a conservative manner:

Chesapeake sold 25% of their Barnett shale operation to Total two years ago (after gas prices had already crashed) for $2.25 billion. After discounting the cash flows received from Total (not all up front) and subtracting the $1.15 billion price of a VPP they subsequently sold in the play, CHK's interest is valued at $5.2 billion. While this play is not their most economic, the large amount of current production there drives the value.

In the Eagle Ford Shale, Marathon paid $3.5 billion or nearly $25,000 per acre to buy out Hilcorp in June. BHP is purchasing Petrohawk for $15 billion, which yields similar metrics but not an exact figure because Petrohawk had other assets. At $20,000 an acre Chesapeake's 450,000 acres is worth $9 billion.

Chesapeake has drilling carries (future payments as part of past joint ventures) due to it from Total, Statoil and CNOOC with a present value of $2.6 billion. The company also owns 34.6% of its publicly traded midstream company (CHKM) worth $1.3 billion.

In the "Niobrara" (now called Powder River and DJ Basin), Chesapeake sold 1/3 of their position to CNOOC this year for a discounted value of $4,200 per acre. There is less information available on this play or good comps from shrewd acquirers (CNOOC doesn't get a lot of respect on the street), so I value the remaining interest in this play at half of that price, or $1.25 billion.

In the Mississippian lime Chesapeake has 1.1 million acres. Sandridge Energy sold a royalty trust (essentially a publicly traded JV interest because the royalties will come on wells that have yet to be drilled) which valued this play at $15,000 per acre. I think the value is currently closer to $5,000 per acre, but without public comps to look at I will use half of this value and say it is worth $2,500 an acre. I also assume not all of CHK's land is "core", so I will assume they only have 800,000 rather than 1.1 million acres. This yields a value for the Mississippian of $2 billion.

Looking at their property plant and equipment, Chesapeake owns one of the largest drilling contractors, service companies, compression companies, oilfield trucking companies etc. Both Frac Tech (their 30% owned completion company) and the newly defined Chesapeake Oilfield Services are likely to be IPO'd next year at a total value of $7 - 10 billion according to the company. This segment will do $1 billion in EBITDA next year, and comps currently trade at the low end of the range given by Chesapeake (HP trades at 6 times EBITDA, HAL at 7.5 times, EXH at 6.5 times). I value this entire segment at only $1.5 billion because that is what I estimate Chesapeake will actually raise in cash from IPO'ing these companies.

Chesapeake has a huge amount of legacy production in the Permian, Appalachian, and Anadarko Basins. I value this at proved-only PV10 value (the discounted value of future cash flows from the proved reserves on these properties) of $13 billion from the last time Chesapeake broke out this value in 2010. I think this is pretty conservative because it ascribes no value to the huge undrilled inventory in the Permian, Granite Wash, and Cleveland plays - all of which are oily. Chesapeake has 835,000 acres in the Permian alone, which is probably worth $15,000 per acre based on comparable transaction (which would value this one portion at $12.5 billion).

This leaves the Marcellus and Haynesville shale plays, which are tougher to value. I previously modeled wells in the Marcellus, Haynesville and Fayetteville shale plays using ten year gas strip prices, known well "type curves", and the next ten years of drilling based on planned rig counts in each play. I assumed wells dried up completely after ten years (there is some controversy over projected 45-65 year well lives), and that drilling ceased after ten years. I assumed 40% of the acreage in each play was worthless and that the undrilled portion of the remaining play was worth only the lowest comparable transaction price. I also discounted the value of current production in each play and got a total value for the Marcellus of $11.7 billion, for the Haynesville of $4 billion (nearly $1.5 of this from current production) and for the Fayetteville of $1.5 billion ($1 billion from production).

After I modeled this about a year ago, BHP bought the Fayetteville asset for $4.75 billion (I assume $500 million of this was for midstream assets - but still more than double my value), so I feel pretty confident that my approach is conservative. Results in the Marcellus have improved since then and Exxon is actively leasing in the Haynesville.

Range Resources is basically a pure play on the Marcellus, so there is a good comp here. If one (generously) values RRC's Permian acreage at $15,000 per acre, and their Anadarko acreage at $5,000 per acre, the market is valuing their 800k acres in the Marcellus at over $10 billion today, or $12,500 per acre. I think this is reasonable, and if I apply this metric to just 60% of CHK's 1.75 million acres in the Marcellus I get a value of $13.1 billion.

BHP's $15 billion purchase of Petrohawk this year almost certainly valued the Haynesville shale at more than double my valuation (or the Eagle Ford much higher), so I feel very comfortable valuation CHK's Marcellus at $12 billion and the Haynesville shale at $4 billion.

The last major asset is the Utica Shale. I believe all of the circumstantial and geophysical evidence suggest that this will be worth the $15-20 billion the company says it will. This joint venture will likely occur in the next month or two and place a firm value on the remaining acreage. For now I will value their 1.25 million acres at the $10,000 figure XOM reportedly paid for Phillips, or $12.5 billion.

There are other assets that could be added, but I think this is a very conservative and firm valuation of the company's assets. Essentially I think they could sell any of these assets tomorrow for the price I give without any problem or disruption to their business (which is why I value the service company etc. only at the cash they will extract from it).

The total (in $ billions):

Barnett shale: $5.2
Eagle Ford shale: $9
Drilling carries: $2.6
CHKM ownership: $1.3
"Niobrara": $1.25
Mississipian: $2
Service companies: $1.5
Permian and Anadarko PV10: $13
Marcellus shale: $12
Haynesville shale: $4
Utica shale: $12.5

Debt and negative working capital: -$12

Equity Value: $52.35 billion

At this valuation, the convertible preferreds would convert to equity so I use a fully diluted share count of 765 million shares, for a value per share of $68.43.

I think the breakup value of the company is probably significantly higher than this, and that the ultimate value (when natural gas recovers in 2012/2013 - which is much longer topic than this write-up) is certainly in triple digits.

Conclusion:

Six times Chesapeake has been criticized for spending too much on land, and six times they have avoided any funding crisis and successfully recouped their investment with a JV, within the timeframe and valuation McClendon claimed. This record will be tested in the next month or two with the Utica joint venture, but history would suggest that the most active driller, with the best information, and a track record of doing identical deals on a similar scale with 100% success knows what they were buying this time around too. Even without these deals, the company is not currently facing a funding crisis, so there is little justification for their huge undervaluation compared to peers, and large market transactions by the oil majors.

The Author, his family, and clients are long CHK equity, preferred stock, and call options

 

Catalyst

Utica Shale JV in Q4 2011
Rising oil/liquids production and associated cash flows in 2012 and beyond
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    Description

    I am recommending a long position in Chesapeake Energy. Chesapeake is the second largest producer of natural gas with one of the lowest cost structures in North America and is rapidly becoming a major producer of oil and natural gas liquids. I think the stock is currently undervalued in the short term due to uncertainty regarding their Utica shale joint venture, and due to underfunded future capex plans (which the aforementioned joint venture would solve).

    In the longer term, there are other reasons that this company is undervalued. The market takes a dim view of the company's management and corporate governance, and many investors think the company is too complex to value due to the amount of non-producing assets, financial engineering, and corporate complexity. I will discuss these issues and take a stab at coming up with a firm conservative valuation below. Questions are more than welcome, thanks.


    Chesapeake Management:

    BEARISH VIEW:

    • Aubrey McClendon and Tom Ward nearly bankrupted CHK in the late 90s by levering up the company to build a huge position in what turned out to be "non-core" Austin Chalk before prices collapsed for a number of years.
    • McClendon lost about $2 Billion personally in 2008, after margining his 30MM share CHK equity position to buy millions more in CHK stock at prices as high as $57.25.
    • The highly compensated ($400k + per annum) and management friendly board of directors paid McClendon $100 million dollars in what amounted to a personal bailout of their Chairman in 2008. The company also elected to buy $12 million dollars of antique maps from McClendon, which decorate company headquarters.
    • Management has declared on numerous occasions that they were done raising capital and buying assets, only to raise billions in capital and expand first into the Haynesville shale and then recently into numerous oil/liquids shale plays.
    • Chesapeake may have expanded beyond their core competency (of producing low cost natural gas) into "lease brokering", an aggressive hedge program that can only be called energy trading, and most recently into oil/liquids production.

    MY TAKE:

    His supporters will say - and we think history will show - that Aubrey McClendon is a visionary. He seems to have learned his lesson with regard to "non-core" acreage in the Austin Chalk, and has created the #1 or #2 "core" leasehold positions in the five largest gas shales and four of the five largest oil shales in the US - all at very attractive prices. This was accomplished by running the most "information only" rigs, building the largest geophysical reservoir evaluation lab, having the most landmen, and having a willingness to move quickly.

    Aubrey McClendon is regarded by many in the investor community as reckless, willing to expand at any cost, and unwilling to be left behind. Analysts I've spoken to don't doubt the value of the assets McClendon has put together, but there is a widespread fear that he will keep "creating value" until it bankrupts the company. Chesapeake expanded aggressively into the Barnett, Marcellus (partially through a fortuitous acquisition of CNR), Fayetteville, Haynesville, Eagle Ford and Niobrara shales. Each time this happened, there were concerns that the company had spent too much money on land and would have a liquidity problem.

    In each play, CHK was able to sell a fractional JV interest for a multiple of what they paid - essentially recouping their entire investment for both the portion they sold and the majority they kept. Each time this has happened, detractors have chalked it up to luck and suggested that the acquirer foolishly overpaid. Considering that the acquirers were BP, Total, Statoil, CNOOC, and PXP, this is very unlikely (except perhaps in the Haynesville, which PXP bought into at the top of the market). Despite this 6/6 record of wildly accretive billion dollar JV deals; the market currently doubts whether CHK can do it again with their recently acquired Utica acreage.

    To understand whether CHK has just been lucky or actually has some advantage in acquiring land, one can look at their recent Eagle Ford JV. In late 2009 and early 2010, they drilled and cored ten vertical wells and acquired 830 square miles of 3D seismic. At Chesapeake's reservoir technology center - which analyses more shale core than the rest of the industry combined - they delineated the area of the "oil window" up-dip as well as the area where the formation was thickest within this window. They identified and avoided the Western section, where despite some of the thickest shale the oil was too immature and viscous to be productive. After fracture simulations at the technology center and actual test wells confirmed the economics of the play, CHK was able to rapidly lease 600,000 acres in the thickest part of the mature oil window for a total cost of $1.4 billion. Within twelve months, CHK was able to sell a 33% stake to CNOOC for $2.16 billion, with half up front and the rest payable over two years as a drilling carry.

    If one uses a present value for the 33% stake purchased by CNOOC of $2 Billion (using a 10% discount rate), that means CHK spent $1.4 billion and turned it into $6 billion of value in just one year - a third of which in cash to immediately recoup their investment. This was not reckless and it was not lucky - Chesapeake was able to turn their temporary informational advantage into a permanent structural advantage; 400,000 net acres in the best part of the play at a negative net cost to the company (after the CNOOC deal). A number of large recent transactions in the Eagle Ford have been completed at prices of more than $20,000 per acre, which would value CHK's 400,000 net acres at $8 Billion dollars (the company actually has 450,000 net acres now due to additional leases signed after the JV deal so this number is higher). To put this in perspective, this is more than $10 per fully diluted share for this one asset, and the net cost to Chesapeake was negative.

    Chesapeake runs 15 "information only" drilling rigs - more than most public E&Ps have for production. This company has consistently been able to gain an informational advantage, not only in finding plays, but in delineating the extent and "core" or sweat-spot of plays others have discovered. By leasing the best acreage, they have consistently turned a 6-month information advantage into a permanent cost-advantage. The company has signaled that this land rush is now essentially over and they have already seen core samples of every depositional basin in the country.

    Chesapeake's management has been creative in raising capital; pioneering the large scale use of VPPs for financing, courting Asian SWFs for capital, and doing the first US oil and gas deal with a Chinese company. Chesapeake is completely vertically integrated, the most active driller, the largest owner of onshore US seismic data, and the largest customer to the service industry. These are major advantages in both producing and discovering gas, and probably also gives them an advantage in their hedging program (which has generated $7.7 billion in realized gains from 2001-2011).

    McClendon may change the direction of the ship more often than investors would like, but his moves have been correct and created value. His bold expansions have been a capitalization on CHK's informational and technological advantages, not the shoot-from-the-hip moves of a manic empire builder. He was right on the gas shales, and is being proven right on the oil shales. Every major expansion McClendon has undertaken has generated a multiple of the expenditure in value to the company. This value is not reflected in the stock, but it is easily verifiable (and will be delineated in the valuation section). The investment community apparently believes McClendon and his team were wrong to create this value because the share price hasn't gone up yet.

    I disagree with those who want Chesapeake to stop doing large and highly accretive land deals, but it looks like that crowd will get their wish in 2012. There are only so many depositional basins in the United States, and at this point, E&P companies have gotten a look at all of them. There is no chance of finding another shale play in Nevada, for instance - shale is the source rock for conventional oil and gas pools, and it only exists where there has been conventional production for years. There could be another large discovery in an existing basin, but it is increasingly unlikely.

    Both McClendon and his (essentially captive) board are very well compensated, but it is not as egregious as the headlines suggest. His "$100 million payday" was really $75 million payable over five years (with no other bonus during this time). He is still very highly compensated and gets a lot of perks, but so do a lot of people at Goldman Sachs - and none of them made a $4 billion gain on one deal for the company in 2010 like McClendon did. While the $12 million purchase of the maps was egregious, it focused shareholders and the media on the poor corporate governance at Chesapeake, which has improved now that the board is under a spotlight. This company is promotional and controversial, and investors need to make a judgment as to whether Aubrey is smart and aggressive or just crazy - the track record of consistently successful value creation suggests the former.

    In January of this year, Lou Simpson, of Berkshire Hathaway and Geico fame joined the board of directors. I view this as a very positive move from a corporate governance standpoint and a vote of confidence in the integrity of management. In August, Mr. Simpson purchased 100,000 shares in the open market at an average price of $27.46.

    I think that the majority of corporate governance issues have been addressed. As to whether management's bold and unapologetic style is something to be concerned about, I think an investor has to look at the track record of what they have accomplished rather than a collection of minor public relations gaffes. If the skill of an investor is ultimately judged by his long term track record, then Aubrey McClendon is one of the greats. The last ten years of hedging, acquisitions, and divestitures has been nearly flawless. Despite a crash in natural gas prices and some minor forays into shale plays that didn't work out (the company wasted about $350 million leasing in Michigan), this company is batting around .800, and has been doing so for years.

    By the end of this year Chesapeake will JV a portion of their newly acquired Utica shale asset in Eastern Ohio. The market did not react well when the company announced a year ago that they planned to spend $1 billion on this - then unnamed - "liquids" shale play. Since then they have spent a total of $1.5 billion, and have announced that they will sell an interest in it by the end of this year. The company says their acreage is worth $15-20 billion. This is a very large number, but the company has a perfect track record at selling joint venture deals within both the timeframe and valuation range they have announced beforehand. If they sell just 25% of the play at a valuation of $15 billion, they will have taken care of any future capex shortfalls and retained an asset worth more than $11 billion dollars at a negative net cost to the company. It is worth noting that Exxon recently bought into this play (buying private Phillips exploration) at a reported $10,000 per acre, which suggests CHK's acreage is worth $12.5 billion - and this was without seeing the results of Chesapeake's wells.


    Financing

    BEARISH VIEW:

    • Chesapeake is one of the most highly levered players in the space, and consistently outspends cash flow.
    • While the company has been successful is selling assets in order to make up the shortfall over the last few years, it is unclear if they will be able to do so going forward, potentially causing a liquidity problem which could lead to dilution.
    • Chesapeake has sold volumetric production payments (VPP) to financial players, getting cash up front for gas to be delivered in the future. This is considered by some to be a form of off-balance sheet debt.


    MY TAKE:

    Chesapeake has been extremely creative in financing their growth. While they have $9.7 billion in debt, they pay a blended rate of only 5.8% and have an average maturity of seven years. They termed out their revolver to 2015 and expanded the capacity from $3.5 billion to $4 billion (with the option to expand to $5 billion).

    The VPP deals are definitely not debt, off balance sheet or not. In these deals, Chesapeake has sold an overriding royalty on certain mature producing wells in a given area for a certain amount of time. The volume they sell is about 80% of what the wells are expected to produce during that timeframe, and while ownership of the wells reverts to Chesapeake after the VPP term, due to decline rates and the time value of money, there is little value left. If these wells blow-up, sand-up, or otherwise disappear, Chesapeake has no further liability. The only liability the company retains is their 20% interest; in the unlikely event that the wells do not produce as much gas as expected, the difference comes out of Chesapeake's remaining 20% interest in the production from that well group - but this is specific to a group of wells, not an area, subsidiary, or any other entity. There is no liability to CHK, other than the potential to give a little more gas out of a given underperforming group of wells, up to but not beyond the ownership interest CHK retains in that group.

    As with the recent Eagle Ford and Niobrara joint ventures, the investment community seems to think that Chesapeake will not be able to get a joint venture done in the Utica and thus will be unable to fund its (discretionary) capex next year, and thus will dilute shareholders. Every piece of evidence, not to mention their track record, suggests otherwise. The company is also planning to sell a royalty trust in their granite wash play for $500 million, will sell more midstream assets into their publicly traded midstream subsidiary, will divest some portion of their 1.1 million acre Mississipian lime play in 2012 and plans to IPO their service business sometime next year (which will likely net them $1.5 billion).

    The bottom line is that investors have been concerned about CHK's ability to fund its expansion for years, and they have always found an intelligent way to do it. There is no chance that CHK won't be able to fund their discretionary spending plans, just a small danger that they will have to go to the capital markets if they somehow can't raise money elsewhere (JV's, VPPs, and midstream MLPs being preferable and much more likely). In addition to the planned monetizations above, they could sell a further interest in the Marcellus shale to Statoil or sell a portion of their huge Permian basin position. Judging from the unbelievable returns on the Eagle Ford investment, it is unlikely that the net result of any major expenditure currently occurring will be dilutive, regardless of the funding source.

     

    Valuation:

    BEARISH VIEW:

    • At current rates of drilling, Chesapeake has 40-60 years worth of inventory in their major shale plays, suggesting that the PV10 value of most of this acreage is negligible.
    • Natural gas prices have fallen since CHK signed major JV deals in the Haynesville and Fayetteville shale plays, suggesting that their partners overpaid and that this acreage is not worth the price implied by these deals.
    • Chesapeake assumes well lives of up to 65 years in calculating estimated ultimate recoveries (EUR) for its wells, potentially understating their finding and developing cost of these wells (for which there is less than a decade of historical data) decline at a greater than expected rate.
    • Some of Chesapeake's acreage may not be "core" or even have any value, particularly their Marcellus acreage in New York (where there is currently a drilling moratorium) and in Central West Virginia.


    MY TAKE:

    In the last two years, numerous comparable transactions by Chesapeake and others have put firm values on the majority of their assets. Chesapeake puts out a monthly presentation which shows all of their plays which may be helpful to look at in conjunction with the below.

    http://www.chk.com/Investors/Documents/Latest_IR_Presentation.pdf

    Like everyone else, I ignore what Chesapeake says their assets are worth, but I have found good public comps for most and have discounted the values of other assets in a conservative manner:

    Chesapeake sold 25% of their Barnett shale operation to Total two years ago (after gas prices had already crashed) for $2.25 billion. After discounting the cash flows received from Total (not all up front) and subtracting the $1.15 billion price of a VPP they subsequently sold in the play, CHK's interest is valued at $5.2 billion. While this play is not their most economic, the large amount of current production there drives the value.

    In the Eagle Ford Shale, Marathon paid $3.5 billion or nearly $25,000 per acre to buy out Hilcorp in June. BHP is purchasing Petrohawk for $15 billion, which yields similar metrics but not an exact figure because Petrohawk had other assets. At $20,000 an acre Chesapeake's 450,000 acres is worth $9 billion.

    Chesapeake has drilling carries (future payments as part of past joint ventures) due to it from Total, Statoil and CNOOC with a present value of $2.6 billion. The company also owns 34.6% of its publicly traded midstream company (CHKM) worth $1.3 billion.

    In the "Niobrara" (now called Powder River and DJ Basin), Chesapeake sold 1/3 of their position to CNOOC this year for a discounted value of $4,200 per acre. There is less information available on this play or good comps from shrewd acquirers (CNOOC doesn't get a lot of respect on the street), so I value the remaining interest in this play at half of that price, or $1.25 billion.

    In the Mississippian lime Chesapeake has 1.1 million acres. Sandridge Energy sold a royalty trust (essentially a publicly traded JV interest because the royalties will come on wells that have yet to be drilled) which valued this play at $15,000 per acre. I think the value is currently closer to $5,000 per acre, but without public comps to look at I will use half of this value and say it is worth $2,500 an acre. I also assume not all of CHK's land is "core", so I will assume they only have 800,000 rather than 1.1 million acres. This yields a value for the Mississippian of $2 billion.

    Looking at their property plant and equipment, Chesapeake owns one of the largest drilling contractors, service companies, compression companies, oilfield trucking companies etc. Both Frac Tech (their 30% owned completion company) and the newly defined Chesapeake Oilfield Services are likely to be IPO'd next year at a total value of $7 - 10 billion according to the company. This segment will do $1 billion in EBITDA next year, and comps currently trade at the low end of the range given by Chesapeake (HP trades at 6 times EBITDA, HAL at 7.5 times, EXH at 6.5 times). I value this entire segment at only $1.5 billion because that is what I estimate Chesapeake will actually raise in cash from IPO'ing these companies.

    Chesapeake has a huge amount of legacy production in the Permian, Appalachian, and Anadarko Basins. I value this at proved-only PV10 value (the discounted value of future cash flows from the proved reserves on these properties) of $13 billion from the last time Chesapeake broke out this value in 2010. I think this is pretty conservative because it ascribes no value to the huge undrilled inventory in the Permian, Granite Wash, and Cleveland plays - all of which are oily. Chesapeake has 835,000 acres in the Permian alone, which is probably worth $15,000 per acre based on comparable transaction (which would value this one portion at $12.5 billion).

    This leaves the Marcellus and Haynesville shale plays, which are tougher to value. I previously modeled wells in the Marcellus, Haynesville and Fayetteville shale plays using ten year gas strip prices, known well "type curves", and the next ten years of drilling based on planned rig counts in each play. I assumed wells dried up completely after ten years (there is some controversy over projected 45-65 year well lives), and that drilling ceased after ten years. I assumed 40% of the acreage in each play was worthless and that the undrilled portion of the remaining play was worth only the lowest comparable transaction price. I also discounted the value of current production in each play and got a total value for the Marcellus of $11.7 billion, for the Haynesville of $4 billion (nearly $1.5 of this from current production) and for the Fayetteville of $1.5 billion ($1 billion from production).

    After I modeled this about a year ago, BHP bought the Fayetteville asset for $4.75 billion (I assume $500 million of this was for midstream assets - but still more than double my value), so I feel pretty confident that my approach is conservative. Results in the Marcellus have improved since then and Exxon is actively leasing in the Haynesville.

    Range Resources is basically a pure play on the Marcellus, so there is a good comp here. If one (generously) values RRC's Permian acreage at $15,000 per acre, and their Anadarko acreage at $5,000 per acre, the market is valuing their 800k acres in the Marcellus at over $10 billion today, or $12,500 per acre. I think this is reasonable, and if I apply this metric to just 60% of CHK's 1.75 million acres in the Marcellus I get a value of $13.1 billion.

    BHP's $15 billion purchase of Petrohawk this year almost certainly valued the Haynesville shale at more than double my valuation (or the Eagle Ford much higher), so I feel very comfortable valuation CHK's Marcellus at $12 billion and the Haynesville shale at $4 billion.

    The last major asset is the Utica Shale. I believe all of the circumstantial and geophysical evidence suggest that this will be worth the $15-20 billion the company says it will. This joint venture will likely occur in the next month or two and place a firm value on the remaining acreage. For now I will value their 1.25 million acres at the $10,000 figure XOM reportedly paid for Phillips, or $12.5 billion.

    There are other assets that could be added, but I think this is a very conservative and firm valuation of the company's assets. Essentially I think they could sell any of these assets tomorrow for the price I give without any problem or disruption to their business (which is why I value the service company etc. only at the cash they will extract from it).

    The total (in $ billions):

    Barnett shale: $5.2
    Eagle Ford shale: $9
    Drilling carries: $2.6
    CHKM ownership: $1.3
    "Niobrara": $1.25
    Mississipian: $2
    Service companies: $1.5
    Permian and Anadarko PV10: $13
    Marcellus shale: $12
    Haynesville shale: $4
    Utica shale: $12.5

    Debt and negative working capital: -$12

    Equity Value: $52.35 billion

    At this valuation, the convertible preferreds would convert to equity so I use a fully diluted share count of 765 million shares, for a value per share of $68.43.

    I think the breakup value of the company is probably significantly higher than this, and that the ultimate value (when natural gas recovers in 2012/2013 - which is much longer topic than this write-up) is certainly in triple digits.

    Conclusion:

    Six times Chesapeake has been criticized for spending too much on land, and six times they have avoided any funding crisis and successfully recouped their investment with a JV, within the timeframe and valuation McClendon claimed. This record will be tested in the next month or two with the Utica joint venture, but history would suggest that the most active driller, with the best information, and a track record of doing identical deals on a similar scale with 100% success knows what they were buying this time around too. Even without these deals, the company is not currently facing a funding crisis, so there is little justification for their huge undervaluation compared to peers, and large market transactions by the oil majors.

    The Author, his family, and clients are long CHK equity, preferred stock, and call options

     I am recommending a long position in Chesapeake Energy. Chesapeake is the second largest producer of natural gas with one of the lowest cost structures in North America and is rapidly becoming a major producer of oil and natural gas liquids. I think the stock is currently undervalued in the short term due to uncertainty regarding their Utica shale joint venture, and due to underfunded future capex plans (which the aforementioned joint venture would solve).

    In the longer term, there are other reasons that this company is undervalued. The market takes a dim view of the company's management and corporate governance, and many investors think the company is too complex to value due to the amount of non-producing assets, financial engineering, and corporate complexity. I will discuss these issues and take a stab at coming up with a firm conservative valuation below. Questions are more than welcome, thanks.


    Chesapeake Management:

    BEARISH VIEW:

    • Aubrey McClendon and Tom Ward nearly bankrupted CHK in the late 90s by levering up the company to build a huge position in what turned out to be "non-core" Austin Chalk before prices collapsed for a number of years.
    • McClendon lost about $2 Billion personally in 2008, after margining his 30MM share CHK equity position to buy millions more in CHK stock at prices as high as $57.25.
    • The highly compensated ($400k + per annum) and management friendly board of directors paid McClendon $100 million dollars in what amounted to a personal bailout of their Chairman in 2008. The company also elected to buy $12 million dollars of antique maps from McClendon, which decorate company headquarters.
    • Management has declared on numerous occasions that they were done raising capital and buying assets, only to raise billions in capital and expand first into the Haynesville shale and then recently into numerous oil/liquids shale plays.
    • Chesapeake may have expanded beyond their core competency (of producing low cost natural gas) into "lease brokering", an aggressive hedge program that can only be called energy trading, and most recently into oil/liquids production.

    MY TAKE:

    His supporters will say - and we think history will show - that Aubrey McClendon is a visionary. He seems to have learned his lesson with regard to "non-core" acreage in the Austin Chalk, and has created the #1 or #2 "core" leasehold positions in the five largest gas shales and four of the five largest oil shales in the US - all at very attractive prices. This was accomplished by running the most "information only" rigs, building the largest geophysical reservoir evaluation lab, having the most landmen, and having a willingness to move quickly.

    Aubrey McClendon is regarded by many in the investor community as reckless, willing to expand at any cost, and unwilling to be left behind. Analysts I've spoken to don't doubt the value of the assets McClendon has put together, but there is a widespread fear that he will keep "creating value" until it bankrupts the company. Chesapeake expanded aggressively into the Barnett, Marcellus (partially through a fortuitous acquisition of CNR), Fayetteville, Haynesville, Eagle Ford and Niobrara shales. Each time this happened, there were concerns that the company had spent too much money on land and would have a liquidity problem.

    In each play, CHK was able to sell a fractional JV interest for a multiple of what they paid - essentially recouping their entire investment for both the portion they sold and the majority they kept. Each time this has happened, detractors have chalked it up to luck and suggested that the acquirer foolishly overpaid. Considering that the acquirers were BP, Total, Statoil, CNOOC, and PXP, this is very unlikely (except perhaps in the Haynesville, which PXP bought into at the top of the market). Despite this 6/6 record of wildly accretive billion dollar JV deals; the market currently doubts whether CHK can do it again with their recently acquired Utica acreage.

    To understand whether CHK has just been lucky or actually has some advantage in acquiring land, one can look at their recent Eagle Ford JV. In late 2009 and early 2010, they drilled and cored ten vertical wells and acquired 830 square miles of 3D seismic. At Chesapeake's reservoir technology center - which analyses more shale core than the rest of the industry combined - they delineated the area of the "oil window" up-dip as well as the area where the formation was thickest within this window. They identified and avoided the Western section, where despite some of the thickest shale the oil was too immature and viscous to be productive. After fracture simulations at the technology center and actual test wells confirmed the economics of the play, CHK was able to rapidly lease 600,000 acres in the thickest part of the mature oil window for a total cost of $1.4 billion. Within twelve months, CHK was able to sell a 33% stake to CNOOC for $2.16 billion, with half up front and the rest payable over two years as a drilling carry.

    If one uses a present value for the 33% stake purchased by CNOOC of $2 Billion (using a 10% discount rate), that means CHK spent $1.4 billion and turned it into $6 billion of value in just one year - a third of which in cash to immediately recoup their investment. This was not reckless and it was not lucky - Chesapeake was able to turn their temporary informational advantage into a permanent structural advantage; 400,000 net acres in the best part of the play at a negative net cost to the company (after the CNOOC deal). A number of large recent transactions in the Eagle Ford have been completed at prices of more than $20,000 per acre, which would value CHK's 400,000 net acres at $8 Billion dollars (the company actually has 450,000 net acres now due to additional leases signed after the JV deal so this number is higher). To put this in perspective, this is more than $10 per fully diluted share for this one asset, and the net cost to Chesapeake was negative.

    Chesapeake runs 15 "information only" drilling rigs - more than most public E&Ps have for production. This company has consistently been able to gain an informational advantage, not only in finding plays, but in delineating the extent and "core" or sweat-spot of plays others have discovered. By leasing the best acreage, they have consistently turned a 6-month information advantage into a permanent cost-advantage. The company has signaled that this land rush is now essentially over and they have already seen core samples of every depositional basin in the country.

    Chesapeake's management has been creative in raising capital; pioneering the large scale use of VPPs for financing, courting Asian SWFs for capital, and doing the first US oil and gas deal with a Chinese company. Chesapeake is completely vertically integrated, the most active driller, the largest owner of onshore US seismic data, and the largest customer to the service industry. These are major advantages in both producing and discovering gas, and probably also gives them an advantage in their hedging program (which has generated $7.7 billion in realized gains from 2001-2011).

    McClendon may change the direction of the ship more often than investors would like, but his moves have been correct and created value. His bold expansions have been a capitalization on CHK's informational and technological advantages, not the shoot-from-the-hip moves of a manic empire builder. He was right on the gas shales, and is being proven right on the oil shales. Every major expansion McClendon has undertaken has generated a multiple of the expenditure in value to the company. This value is not reflected in the stock, but it is easily verifiable (and will be delineated in the valuation section). The investment community apparently believes McClendon and his team were wrong to create this value because the share price hasn't gone up yet.

    I disagree with those who want Chesapeake to stop doing large and highly accretive land deals, but it looks like that crowd will get their wish in 2012. There are only so many depositional basins in the United States, and at this point, E&P companies have gotten a look at all of them. There is no chance of finding another shale play in Nevada, for instance - shale is the source rock for conventional oil and gas pools, and it only exists where there has been conventional production for years. There could be another large discovery in an existing basin, but it is increasingly unlikely.

    Both McClendon and his (essentially captive) board are very well compensated, but it is not as egregious as the headlines suggest. His "$100 million payday" was really $75 million payable over five years (with no other bonus during this time). He is still very highly compensated and gets a lot of perks, but so do a lot of people at Goldman Sachs - and none of them made a $4 billion gain on one deal for the company in 2010 like McClendon did. While the $12 million purchase of the maps was egregious, it focused shareholders and the media on the poor corporate governance at Chesapeake, which has improved now that the board is under a spotlight. This company is promotional and controversial, and investors need to make a judgment as to whether Aubrey is smart and aggressive or just crazy - the track record of consistently successful value creation suggests the former.

    In January of this year, Lou Simpson, of Berkshire Hathaway and Geico fame joined the board of directors. I view this as a very positive move from a corporate governance standpoint and a vote of confidence in the integrity of management. In August, Mr. Simpson purchased 100,000 shares in the open market at an average price of $27.46.

    I think that the majority of corporate governance issues have been addressed. As to whether management's bold and unapologetic style is something to be concerned about, I think an investor has to look at the track record of what they have accomplished rather than a collection of minor public relations gaffes. If the skill of an investor is ultimately judged by his long term track record, then Aubrey McClendon is one of the greats. The last ten years of hedging, acquisitions, and divestitures has been nearly flawless. Despite a crash in natural gas prices and some minor forays into shale plays that didn't work out (the company wasted about $350 million leasing in Michigan), this company is batting around .800, and has been doing so for years.

    By the end of this year Chesapeake will JV a portion of their newly acquired Utica shale asset in Eastern Ohio. The market did not react well when the company announced a year ago that they planned to spend $1 billion on this - then unnamed - "liquids" shale play. Since then they have spent a total of $1.5 billion, and have announced that they will sell an interest in it by the end of this year. The company says their acreage is worth $15-20 billion. This is a very large number, but the company has a perfect track record at selling joint venture deals within both the timeframe and valuation range they have announced beforehand. If they sell just 25% of the play at a valuation of $15 billion, they will have taken care of any future capex shortfalls and retained an asset worth more than $11 billion dollars at a negative net cost to the company. It is worth noting that Exxon recently bought into this play (buying private Phillips exploration) at a reported $10,000 per acre, which suggests CHK's acreage is worth $12.5 billion - and this was without seeing the results of Chesapeake's wells.


    Financing

    BEARISH VIEW:

    • Chesapeake is one of the most highly levered players in the space, and consistently outspends cash flow.
    • While the company has been successful is selling assets in order to make up the shortfall over the last few years, it is unclear if they will be able to do so going forward, potentially causing a liquidity problem which could lead to dilution.
    • Chesapeake has sold volumetric production payments (VPP) to financial players, getting cash up front for gas to be delivered in the future. This is considered by some to be a form of off-balance sheet debt.


    MY TAKE:

    Chesapeake has been extremely creative in financing their growth. While they have $9.7 billion in debt, they pay a blended rate of only 5.8% and have an average maturity of seven years. They termed out their revolver to 2015 and expanded the capacity from $3.5 billion to $4 billion (with the option to expand to $5 billion).

    The VPP deals are definitely not debt, off balance sheet or not. In these deals, Chesapeake has sold an overriding royalty on certain mature producing wells in a given area for a certain amount of time. The volume they sell is about 80% of what the wells are expected to produce during that timeframe, and while ownership of the wells reverts to Chesapeake after the VPP term, due to decline rates and the time value of money, there is little value left. If these wells blow-up, sand-up, or otherwise disappear, Chesapeake has no further liability. The only liability the company retains is their 20% interest; in the unlikely event that the wells do not produce as much gas as expected, the difference comes out of Chesapeake's remaining 20% interest in the production from that well group - but this is specific to a group of wells, not an area, subsidiary, or any other entity. There is no liability to CHK, other than the potential to give a little more gas out of a given underperforming group of wells, up to but not beyond the ownership interest CHK retains in that group.

    As with the recent Eagle Ford and Niobrara joint ventures, the investment community seems to think that Chesapeake will not be able to get a joint venture done in the Utica and thus will be unable to fund its (discretionary) capex next year, and thus will dilute shareholders. Every piece of evidence, not to mention their track record, suggests otherwise. The company is also planning to sell a royalty trust in their granite wash play for $500 million, will sell more midstream assets into their publicly traded midstream subsidiary, will divest some portion of their 1.1 million acre Mississipian lime play in 2012 and plans to IPO their service business sometime next year (which will likely net them $1.5 billion).

    The bottom line is that investors have been concerned about CHK's ability to fund its expansion for years, and they have always found an intelligent way to do it. There is no chance that CHK won't be able to fund their discretionary spending plans, just a small danger that they will have to go to the capital markets if they somehow can't raise money elsewhere (JV's, VPPs, and midstream MLPs being preferable and much more likely). In addition to the planned monetizations above, they could sell a further interest in the Marcellus shale to Statoil or sell a portion of their huge Permian basin position. Judging from the unbelievable returns on the Eagle Ford investment, it is unlikely that the net result of any major expenditure currently occurring will be dilutive, regardless of the funding source.

     

    Valuation:

    BEARISH VIEW:

    • At current rates of drilling, Chesapeake has 40-60 years worth of inventory in their major shale plays, suggesting that the PV10 value of most of this acreage is negligible.
    • Natural gas prices have fallen since CHK signed major JV deals in the Haynesville and Fayetteville shale plays, suggesting that their partners overpaid and that this acreage is not worth the price implied by these deals.
    • Chesapeake assumes well lives of up to 65 years in calculating estimated ultimate recoveries (EUR) for its wells, potentially understating their finding and developing cost of these wells (for which there is less than a decade of historical data) decline at a greater than expected rate.
    • Some of Chesapeake's acreage may not be "core" or even have any value, particularly their Marcellus acreage in New York (where there is currently a drilling moratorium) and in Central West Virginia.


    MY TAKE:

    In the last two years, numerous comparable transactions by Chesapeake and others have put firm values on the majority of their assets. Chesapeake puts out a monthly presentation which shows all of their plays which may be helpful to look at in conjunction with the below.

    http://www.chk.com/Investors/Documents/Latest_IR_Presentation.pdf

    Like everyone else, I ignore what Chesapeake says their assets are worth, but I have found good public comps for most and have discounted the values of other assets in a conservative manner:

    Chesapeake sold 25% of their Barnett shale operation to Total two years ago (after gas prices had already crashed) for $2.25 billion. After discounting the cash flows received from Total (not all up front) and subtracting the $1.15 billion price of a VPP they subsequently sold in the play, CHK's interest is valued at $5.2 billion. While this play is not their most economic, the large amount of current production there drives the value.

    In the Eagle Ford Shale, Marathon paid $3.5 billion or nearly $25,000 per acre to buy out Hilcorp in June. BHP is purchasing Petrohawk for $15 billion, which yields similar metrics but not an exact figure because Petrohawk had other assets. At $20,000 an acre Chesapeake's 450,000 acres is worth $9 billion.

    Chesapeake has drilling carries (future payments as part of past joint ventures) due to it from Total, Statoil and CNOOC with a present value of $2.6 billion. The company also owns 34.6% of its publicly traded midstream company (CHKM) worth $1.3 billion.

    In the "Niobrara" (now called Powder River and DJ Basin), Chesapeake sold 1/3 of their position to CNOOC this year for a discounted value of $4,200 per acre. There is less information available on this play or good comps from shrewd acquirers (CNOOC doesn't get a lot of respect on the street), so I value the remaining interest in this play at half of that price, or $1.25 billion.

    In the Mississippian lime Chesapeake has 1.1 million acres. Sandridge Energy sold a royalty trust (essentially a publicly traded JV interest because the royalties will come on wells that have yet to be drilled) which valued this play at $15,000 per acre. I think the value is currently closer to $5,000 per acre, but without public comps to look at I will use half of this value and say it is worth $2,500 an acre. I also assume not all of CHK's land is "core", so I will assume they only have 800,000 rather than 1.1 million acres. This yields a value for the Mississippian of $2 billion.

    Looking at their property plant and equipment, Chesapeake owns one of the largest drilling contractors, service companies, compression companies, oilfield trucking companies etc. Both Frac Tech (their 30% owned completion company) and the newly defined Chesapeake Oilfield Services are likely to be IPO'd next year at a total value of $7 - 10 billion according to the company. This segment will do $1 billion in EBITDA next year, and comps currently trade at the low end of the range given by Chesapeake (HP trades at 6 times EBITDA, HAL at 7.5 times, EXH at 6.5 times). I value this entire segment at only $1.5 billion because that is what I estimate Chesapeake will actually raise in cash from IPO'ing these companies.

    Chesapeake has a huge amount of legacy production in the Permian, Appalachian, and Anadarko Basins. I value this at proved-only PV10 value (the discounted value of future cash flows from the proved reserves on these properties) of $13 billion from the last time Chesapeake broke out this value in 2010. I think this is pretty conservative because it ascribes no value to the huge undrilled inventory in the Permian, Granite Wash, and Cleveland plays - all of which are oily. Chesapeake has 835,000 acres in the Permian alone, which is probably worth $15,000 per acre based on comparable transaction (which would value this one portion at $12.5 billion).

    This leaves the Marcellus and Haynesville shale plays, which are tougher to value. I previously modeled wells in the Marcellus, Haynesville and Fayetteville shale plays using ten year gas strip prices, known well "type curves", and the next ten years of drilling based on planned rig counts in each play. I assumed wells dried up completely after ten years (there is some controversy over projected 45-65 year well lives), and that drilling ceased after ten years. I assumed 40% of the acreage in each play was worthless and that the undrilled portion of the remaining play was worth only the lowest comparable transaction price. I also discounted the value of current production in each play and got a total value for the Marcellus of $11.7 billion, for the Haynesville of $4 billion (nearly $1.5 of this from current production) and for the Fayetteville of $1.5 billion ($1 billion from production).

    After I modeled this about a year ago, BHP bought the Fayetteville asset for $4.75 billion (I assume $500 million of this was for midstream assets - but still more than double my value), so I feel pretty confident that my approach is conservative. Results in the Marcellus have improved since then and Exxon is actively leasing in the Haynesville.

    Range Resources is basically a pure play on the Marcellus, so there is a good comp here. If one (generously) values RRC's Permian acreage at $15,000 per acre, and their Anadarko acreage at $5,000 per acre, the market is valuing their 800k acres in the Marcellus at over $10 billion today, or $12,500 per acre. I think this is reasonable, and if I apply this metric to just 60% of CHK's 1.75 million acres in the Marcellus I get a value of $13.1 billion.

    BHP's $15 billion purchase of Petrohawk this year almost certainly valued the Haynesville shale at more than double my valuation (or the Eagle Ford much higher), so I feel very comfortable valuation CHK's Marcellus at $12 billion and the Haynesville shale at $4 billion.

    The last major asset is the Utica Shale. I believe all of the circumstantial and geophysical evidence suggest that this will be worth the $15-20 billion the company says it will. This joint venture will likely occur in the next month or two and place a firm value on the remaining acreage. For now I will value their 1.25 million acres at the $10,000 figure XOM reportedly paid for Phillips, or $12.5 billion.

    There are other assets that could be added, but I think this is a very conservative and firm valuation of the company's assets. Essentially I think they could sell any of these assets tomorrow for the price I give without any problem or disruption to their business (which is why I value the service company etc. only at the cash they will extract from it).

    The total (in $ billions):

    Barnett shale: $5.2
    Eagle Ford shale: $9
    Drilling carries: $2.6
    CHKM ownership: $1.3
    "Niobrara": $1.25
    Mississipian: $2
    Service companies: $1.5
    Permian and Anadarko PV10: $13
    Marcellus shale: $12
    Haynesville shale: $4
    Utica shale: $12.5

    Debt and negative working capital: -$12

    Equity Value: $52.35 billion

    At this valuation, the convertible preferreds would convert to equity so I use a fully diluted share count of 765 million shares, for a value per share of $68.43.

    I think the breakup value of the company is probably significantly higher than this, and that the ultimate value (when natural gas recovers in 2012/2013 - which is much longer topic than this write-up) is certainly in triple digits.

    Conclusion:

    Six times Chesapeake has been criticized for spending too much on land, and six times they have avoided any funding crisis and successfully recouped their investment with a JV, within the timeframe and valuation McClendon claimed. This record will be tested in the next month or two with the Utica joint venture, but history would suggest that the most active driller, with the best information, and a track record of doing identical deals on a similar scale with 100% success knows what they were buying this time around too. Even without these deals, the company is not currently facing a funding crisis, so there is little justification for their huge undervaluation compared to peers, and large market transactions by the oil majors.

    The Author, his family, and clients are long CHK equity, preferred stock, and call options

     

    Catalyst

    Utica Shale JV in Q4 2011
    Rising oil/liquids production and associated cash flows in 2012 and beyond

    Messages


    SubjectRE: RE: trouble uploading - sorry
    Entry10/07/2011 04:31 PM
    Membertyler939
    " One of the greats"?  I think you are confusing Aubrey with Lenny Dykestra

    SubjectRE: Questions
    Entry10/10/2011 03:15 AM
    Membersugar
    Snarfy,
     
    I'm not sure your last comment is entirely fair. Look at PetroHawk. Where was the value creation until the day BHP bought them out? A lot of independent E&P companies are run with the intent to divest parts or the whole to a major at some point. And there are some transactions that have highlighted value creation - the outright sale of the Fayetteville asset (for what I think was a lot more than CHK put into it).
     
    That being said, I think your point about CHK driving along the edge of the cliff is valid, and it is disappointing to not see CHK take more chips off the table to deleverage and allow the market to award them more value for what they've put together.
     
    I personally don't own CHK stock for many of the reasons you pointed out. That being said, I know a number of people who are short the stock who I think are making a pretty big mistake. I don't see how you short a stock trading for under half of its SOTP, especially after the positive Utica results.

    SubjectRE: RE: RE: Questions
    Entry10/10/2011 02:48 PM
    Membersugar
    Not at the moment, but their assets are. The current disconnect between the public and private market value of some assets and companies is incredible.
     
    Cheseapeake is not the best example of this by any stretch of the imagination, although the Fayetteville transaction was pretty incredible. I prefer smaller, simpler plays with more discrete catalysts (and less debt).

    SubjectRE: Better Examples
    Entry10/10/2011 06:24 PM
    Membersugar
    I've posted a couple on here - Gastar and Molopo. Gastar is developing acreage right now, will have 7-10 well results by the end of the year, and that acreage is likely worth $20,000/acre. Molopo is selling assets and refocusing on a couple areas that have similar potential. Both are very simple, clean stories - one or two assets, both companies will delineate the assets and then sell them.
     
    Another company I like here is US Energy (USEG). Incredible Bakken and Eagle Ford exposure, and its trading under the value of its proved reserves (or the value of its current production, depending on how you want to approach it).
     
    These are actually three of my largest positions at the moment, so I have my money where my mouth is.
     
    Another interesting story is Primary Petroleum - its a small position for me, but literally there should be a JV announced any day now that could imply a value of 2x the current market cap, and they have no debt.

    SubjectRE: RE: Better Examples
    Entry10/10/2011 07:27 PM
    Memberdr123

    Sugar,

    This is my first time taking a look at USEG and it sure sounds interesting.  Can you please elaborate on its "trading under the value of its proved reserves"?

    Per the 2010 10-K, the YE 2010 standardized measure of discounted net cash flows (after-tax NPV-10) associated with 1P reserves is ~$46mil using $79.43/barrel oil, $4.38/MMbtu NG - arguably reasonable prices.  I see current EV ~65mil (FactSet).  Are there issues with the above numbers or have there been significant proved reserve additions since?


    SubjectRE: RE: RE: Better Examples
    Entry10/10/2011 08:41 PM
    Membersugar
    They've drilled a number of wells since then. I'd value the reserves using their production numbers as a proxy. They're currently producing ~1000 bopd from the bakken and eagle ford, which is declining at about 25% per year (which is low for a shale play). Recent transactions have valued such production consistently at over $70,000 per bopd, or $70 million for USEG. They also have 500 boepd from the gulf coast, which should sell for over $30,000 per boepd, or $15 million for USEG. So just on a production value basis, that gets you to $85 million. And those are low metrics, production in the Bakken sold for as high as $170,000 per bopd earlier this year.
     
    They also have 6,000 net core undeveloped bakken acres, ~4,000 net core undeveloped eagle ford acres, ~30,000 net non-core bakken acres, a multi hundred unit multi family complex in Wyoming, a molybdenum mine in the permitting phase in Colorado, an exploratory oil prospect in California, etc. I think all that can easily get you to another $80+ million. And management has recently indicated they may put their current Bakken production up for sale to fund the development of their other assets. So they could be seeing $70 million come in soon.
     
    I'm working on a writeup for VIC on USEG. The big, big downside risk is management - they overpay themselves and are viewed as nepotistic - the CEO and President are borthers, they company pilot (yes, they own a plane and have a pilot) is another brother, and their newphew is the head of IR.
     
    Anyway, USEG is super cheap, but is a smaller position for me than Gastar and Molopo, I think both of those have clearer upside, fewer management issues, and are more likely to realize value for shareholders in the short, medium and longer term.

    Subjectreply to Teton
    Entry10/11/2011 10:45 AM
    Memberncs590
    I know this is a controversial investment and that Aubrey is an extremely polarizing figure, so I do not want to get into a big argument about this. 
    To clarify my point though, if Aubrey was running a P/E firm that made 6 multi billion dollar investments over the last 6 years, and was able to sell off 25-35% of these investments within a year or two to recover his entire cost basis, I think we would all agree that he is a very successful private equity investor with a near perfect track record (assuming that the value of the remaining stakes he held onto wasn't impared).  I think the recent transactions in almost every play CHK is involved in suggest this is not that case and that the ROIC of these investments is very high - BUT not at all reflected in the current stock price.
    Similarly, Aubrey (and his team) have had $7.7 billion of realized gains hedging their natural gas and oil (and un-hedging, and re-hedging, and selling and buying back call options).  This is a phenomonal amount of money to make in ten years and if Aubrey was running a hedge fund that invested in oil and gas and tried to make directional bets, I think after the last ten years of results we would have to admit that he/they are very good at it.
    I am more than happy to agree with you that if the job of a CEO is to get his stock price up, then Aubrey has done an abysmal job over the last few years - and I do think that is a long enough time frame to make a fair judgement.  This was the point I was trying to make when I said that Aubrey is a great investor . . . I think he has created a ton of value, but I fully agree that he has probably done more to drive his stock price down than up over this timeframe. 

    SubjectRE: Questions replay to Snarfy
    Entry10/11/2011 11:01 AM
    Memberncs590
    Snarfy,
    Thank you for the questions.
    1) I think my valuation essentially answers this question.  I put no value on their ongoing ability to play the land game.  Which metrics do you think are mediocre?  Chesapeake is one of the lowest cost producers of natural gas, and their liquids/oil projects have very high RoRs.  If you are referring to their valuation versus "peers" like DVN etc, I think that is a red herring.  CHK's real peers (companies with huge unbooked tier 1 shale reserves) are companies like RRC and HK.  CHK just happens to be a larger company and is lumped in with more mature companies like DVN that don't have a majority of their value in unproved land.  HK was taken out at 11 times 2011 EBITDA and RRC trades at 15 times 2011 EBITDA.  Chesapeake holds assets nearly identical to these two companies, but of bigger size in the same basins.  CHK trades at only 6 times 2011 EBITDA.
    2) I have heard this same criticism from a number of people, and I have to conclude that they either know something I don't or they are just lazy and/or shortsighted.  I have tried to get around this issue in my valuation by only using valuations for CHK's assets that oil majors have directly or indirectly put on these assets in recent transactions.  I have tried to avoid using transactions by Chinese or Indian companies because they may be in it for the technology as much as the asset, but when XOM, TOT, Statoil, RDS, etc, bet billions of dollars on an asset, I am willing to use their valuation as a benchmark. 
    3) Aubrey is running a fifedom down in Oklahoma and I don't deny this in any way.  I think this has actually been an asset in the last few years as other boards might not have gona along with the - company saving - move into gas and then oil shales.  This could certainly be a liability in the future and I readily admit that.
    4) because the company uses full cost accounting (which I think is appropriate for a shale company) they multi billion dollar gains on selling stakes in their shale plays don't flow through the income statement, they just reduce the "full coost pool" for that asset.  This was all I was trying to say.  If they used succesful efforts accounting and took a gain on sale with each JV then earnings (and taxes) would be higher by more than a billion dollars each year.

    Subjectis CHK saleable
    Entry10/11/2011 11:34 AM
    Memberncs590
    I think Chesapeake is definately saleable, but probably only to COP, RDS, TOT.  XOM is probably out of the bidding because they are building a parallel CHK, and I don't think it is politically feasable for any of the asian companies to buy out CHK.  I think it would make a lot of sense for a company like Berkshire to buy CHK, but I don't think Buffett wants to spend the rest of his life answering questions on fraccing.
    .
    As for if the company is for sale . . . absolutely not!  Aubrey has a captive board, constantly claims the stock is worth more than $100, and doesn't own a big equity stake.  Unfriendly takeovers in the oil patch are very rare, and I don't think any company would pay a price that Aubrey or his board would have to agree to. 
    .
    There are two other options, one likely and one not.  The first is further sales of entire assets like the Fayetteville shale.  This asset was valued in various sellside reports last year at less than $500 million, but was sold for $4.75 to BHP (who I do not think is a dumb acquirer).  I would like to see the company sell the Permian basin asset completely at this point.  The permian is probably worth at least ten billion, is a relatively mature and well known asset, and is oily.  They could probably get close to full value there now and there are a number of players in the area that could afford it - notably XOM and OXY.
    .
    The only other option, which I think is unlikely, is a private equity takeout.  Provided financing was available I think this could be done at a very high price (say $57.25, the price of the highest equity follow on), which would save face for aubrey and convince shareholders.  Aubrey could keep running the company and eventually take it public again as a huge succes in a higher gas price envirnonment. 
    .
    In summary: no I do not think this company will be sold.  But perhaps a large asset like the Permian basin properties will be. 

    SubjectRE: reply to Teton
    Entry10/11/2011 05:19 PM
    Memberdr123

    Ncs,

    This is a good write-up and I do not disagree with you on CHK's valuation and upside relative to such peers as RRC and SWN.  There are plenty of more expensive and/or poorer-run and "hairier" shorts out there so I am not sure why folks are so fixated on this one.  Per sugar, there are also cheaper and simpler names with less hair though mostly in the small/micro-cap space.

    I do have an issue with your using the last 6 years as an appropriate barometer for Aubrey's value creation acumen given the length of cycles in this industry and the tailwinds after the majors left NA onshore business for dead in the late 90's, just as the technical foundation of the unconventional revolution was emerging.  In general, I think one has to be very careful when looking at "value creation" in transactional sense.  Your "transactional" criteria may be loose enough to label as "value creation" the activities of the mortgage and homebuilding (land flipping?) industries in 20001-2007 with their stellar records up until the music stopped.  Without getting into a religious argument over this contentious comparison and the long-term commodity prices and lease values, it seems at least a material possibility that given the continuous supply of new plays (all low-cost, naturally) and the general inability of the recent purchasers to generate FCF, once the music stops recent transactions will resemble those for undeveloped Florida or Nevada land.

    Also, after what China has done to the multi-year track record of value creation in the solar space, it is interesting to note that per the EIA China has larger estimated recoverable shale gas resources than US and Canada combined (http://www.eia.gov/analysis/studies/worldshalegas/) so hope for LNG story to bail out the US market in the long-term could prove futile.

     


    SubjectRE: RE: Better Examples
    Entry10/13/2011 04:38 PM
    Memberncs590
    Sugar,
    .
    I liked your gastar write-up and agree with your thesis.  I also generally agree with you that simple stories with one or two assets have done better for the last couple years.  I certainly would have been better off owning HK rather than CHK up until this point, and Range is likely to be bought out before CHK's stock price reflects the value of its marcellus acreage.
    .
    I have tried to come up with a very conservative value for CHK in my write-up, but one can make a solid case that it is worth $100+ today, or is roughly as cheap as Gastar and similar opportunities.  I left out a number of very valuable assets (including the 10% stake in GST owned by CHK).
    .
    I started by looking at US natural gas (which is at $3.50, versus worldwide prices of $10-15 and oil at $18 equivilent even today), and then chose CHK as the best investment vehicle.  I agree with you that Gastar is likely to triple first on well results or other news, but to make a long term bet on natural gas, I think there is no better or cheaper play than CHK.
    .
    Along those lines, I think CHK is much safer, cheaper, and much less likely to have something go wrong.  When the financial crisis hit in 2008, CHK was able to immediately draw their entire $3 billion revolver overnight and sell a multi-billion stake in the Marcellus to Statoil.  Smaller shale companies are simply in a different league and are much more risky in terms of individual field results, weak energy markets or broader financial stress.  I think there is essentially no downside to owning CHK at these prices, come hell or high water - something that cannot be said of smaller companies in this space.

    SubjectRE: RE: RE: reply to Teton
    Entry10/17/2011 12:15 PM
    Memberncs590
    Teton,
    .
    Thank you for your very honest response.  It doesn't sound like I am going to be convincing you to change your mind, but I would like to respond to your points.
    .
    You seem to be using the currently low share price (and by correlation historical share performance) to claim this is a bad company/investment.  My thesis is that the current share price is far too low.  I covered the issue of VPPs in my write-up, and I think is is very clear that they are not off balance sheet debt.  The associated assets are no longer on the balance sheet and the only potential liability would be for specific declining assets worth only 20% of the original VPP amount.  With regard to a "discount" for the entire balance sheet being subjective, I think I do a decent job of objectively valueing their assets in a conservative manner.  I think their liabilities are very straightforward, but if you think an additional $5 billion haircut is justified to account for VPP's, calls sold short, other hedging and unknown risk . . . I still think this is a very compelling investment opportunity.
    .
    I'm not sure what you are referring to when you say that if the "majors have three offers and one is from CHK" it goes to the bottom of the pile.  Are you talking about CHK leasing land from the majors?  I don't know where this would be the case, or why they would take a lower offer.  Are you referring to something else?  I'm not sure what the Enron reference is, other than that CHK uses creative sources of financing.
    .
    I agree with you on the hedging point, and I put in my write-up that they are clearly speculating.  That being said, they only speculate on the short side (which is naturally hedged by them being long actual production).  In addition, I think them being the most active driller and service customer in the most shale plays could give them an advantage in hedgeing/unhedging/rehedging opportunistically.  The $7.7 billion in realized gains suggest this is true, but I agree that this could be a fluke, so I don't value their hedging program as being worth anything.  I don't think it is a liability either, but as I said before, even if it is a future liability I believe the value is very compelling today.
    .
    I'm not sure what your point is with regard to debt/CDS other than that CHK's bonds are lower rated than some peers.  With regard to the many sources of creative financing in the last few years, I think it has been opportunistic rather than desperate.  They could always have sold off good assets as many other companies were forced to, I think CHK's approach preserved more value for shareholders - although it seems to have aggravated the sell-side.
    .
    I don't agree with your assesment that CHK will "spend the future . . . selling off viable pieces of their business".  CHK has done a great job buying big positions in a play and then selling a portion, this is an asset they just picked up and flipped at a large profit though, not the crown jewels.  Selling the Fayetteville was a phenomonal deal.  Going forward I don't think they will need to sell anything unless they expand further, but even so I think all of their sales, like their financings, have been the best source of capital available at that time.  Despite the low share price, I think this capital has been reinvested very wisely and at high returns.
    .
    Thanks for the comments and I take no offense at all and congratulations on the whole foods

    SubjectThoughts?
    Entry10/20/2011 10:10 PM
    Memberbackinthetetons34
    I have attacked your idea (and continue to) and for that I apologize.  I was gathering some data today and compiled the following. Why will the future be different than the past?  Same management, etc.  The below shows a monumental relative and absolute failure IMO.  Absolutely amazing...Think about what occurred in commodities over the period - from price escalation to volatility to oversupply of NG.  Note that Anadarko uses successful efforts...
     

    12/30/2001 6/30/2011
    Anadarko

      SE 6,365 21,471
      RE 1,276 15,119



    Devon

      SE 3,259 21,428
      RE (147) 14,901



    Apache

      SE 4,418 26,667
      RE 1,336 16,463



    CHK

      SE 767 15,483
      RE (443) 411




    SubjectRE: Thoughts?
    Entry10/25/2011 11:12 AM
    Memberncs590
    Teton,
    .
    I appreciate the dialogue - it's why I posted the idea.
    .
    There are three reasons that I think the figures you have posted are not relevant.  First, you (like most sell-side analysts) are comparting CHK to comparably sized diversified E&P businesses, when really CHK should be compared to other shale companies with huge unbooked reserves.  Secondly, natural gas currently trades below the marginal cost production and is at or very close to the bottom in terms of the spot price and strip - I don't think that is a fair time to claim that a low-cost commodity producer has destroyed value.  Finally, as you mentioned, succesful efforts versus full cost accounting (but more importantly the difference between shale exploration and drilling large offshore wells like Anadarko).
    .
    Two comparable companies to CHK are RRC and HK.  CHK has the most directly comparable position (in terms of both land, liquids mix and production) to RRC in the Marcellus, but larger.  In the Haynesville and Eagle Ford CHK has the most comparable position to HK, but again a larger position.  CHK's marcellus, haynesville and Eagle ford is essentially analogous to RRC+HK, but larger.  I value these three assets in my valuation at a total of $25 billion net to CHK.  The current EV of RRC is $13.3 billion and HK was bought out this year at $15.1 billion, so the public and private markets are valuing these assets at $28.4 billion, which is above my valuation (and my valuation implies CHK is a triple).  RRC is expected to be bought out, so that is also something of a private market value.
    .
    With respect to retained earnings and SE, RRC has retained earnings of just $400 million and Petrohawk had reatined earnings of negative $1.1 billion when it was bought out.  This is a function of the low current price of natural gas, full cost accounting, and the fact that GAAP accounting does not have any way to reflect the real value of shale assets.
    .
    With respect to succesful efforts versus full-cost (which I believe is the correct treatment for shale asssets as well as being more tax efficient), CHK has monetized $12.5 billion of its shale assets in Joint ventures, which do not flow through the income statement (which would generate a taxable gain) but simply reduce the full cost pool.  Assuming CHK had a cost basis of 25% of the sale price, and that the gain on sale was taxable at 35%, these joint ventures would have added $6.1 billion (roughly $10 per share) to earnings and retained earnings.  If you include the Fayetteville sale (which will generate a taxable gain) and the VPP sales, CHK has monetized $20 billion of its assets at metrics similar to the above calculation - and this is in a low gas price environment.
    .
    As an aside, sell side analysts occasionally say that CHK trades at a premium to "the group", which is the large cap companies you name above, which don't have huge unboooked shale reserves or the growth profile of CHK.  CHK trades at an EV/Ebitda of about 6, which is around the level of "the group", but the more approriate comps like RRC trade at 12.2 time and RRC was taken out at 11 times.

    SubjectRE: RE: Thoughts?
    Entry10/25/2011 01:05 PM
    Memberdr123

    “"the group", which is the large cap companies you name above, which don't have huge unboooked shale reserves or the growth profile of CHK.”

    I don’t think this is an accurate statement.  Given the enormous shale resources in the US and worldwide with decades of drilling inventory in the cores alone, there is nothing particularly unique about companies having "huge tracts of land."  Take APA’s 1.7MM acres in Neuquen basin in Argentina:  YPF’s vertical wells targeting Vaca Muerta’s condensate window (over a dozen on production now) compare very favorably to Eagleford while development in the gas window actually stands a chance of making money with the >=$6.00/Mcf realized pricing under the gas+ program.  I would bet APA is far more likely to make money (in a sense of actual positive free cash flow) in their Neuquen development than CHK is in Marcellus.  YPF’s leverage to shales is even crazier.  Hess is out in China (estimated to have world’s largest technically recoverable shale resource) and Australia.  These three are just examples that immediately come to mind and I am not even particularly familiar with the large-cap E&P space.  CHK seems to have caught on to the trend and is branching out internationally.  I’m familiar with their efforts in the Karoo basin in South Africa (world’s 5th largest estimated shale gas resource).  Though they have been a bit late to the party there and is stuck with the crappiest acreage in the basin.

    CHK is different in their level of aggressiveness for sure but I think it is far from obvious that they should be rewarded for having say 40 years of organic drilling inventory when the group as a whole has 30 years and new plays are continuing to emerge increasing the aggregate inventory and pressuring prices.

    As for the imminent RRC takeout...  Stranger things have happened but at ~100% premium to the private market value for Marcellus acreage and industry focus switching to greener pastures this will be an interesting story to watch.


    Subjectreply to dr123
    Entry10/25/2011 02:06 PM
    Memberncs590
    dr123,
     
    I don't think you can ignore fifteen or so multi-billion dollar purchases (with the oil majors as the usual purchasers) of shale assets in the US.  Looking at RRC, HK (bought out), XTO (bought out), XCO (management attempted to buy out), KWK (management attempted to buy out), BEXP (bought out) and a number of asset sales, there is clearly something unique about having "huge tracts of land" if it is in the right place.  Exxon, Shell, Total and the other majors have bet more than $100 billion on it.
     
    As for international shales, there is no infrastructure so none of them will be developed to a meaningful degree in the next ten years.  CHK is not expanding into South Africa, they are just helping Statoil/Sasol explore there as part of an agreement (from when Statoil bought into the Marcellus and where Sasol is looking to commercialize gas-to-liquids in North America).
     
    As for the Vaca Muerta, I am less familiar with international shales because I don't think they have anything to do with my thesis or anything to do with CHK, but from what I have seen it looks impressive.  BOE.cn looks like a good way to play and it and has a very detailed presentation, but it is unclear to me how economic these wells will ultimately be or how permiability will effect the economics.  The need for big roads, lodging, frac crews, water, water disposal, midstream pipelines, gas pipelines, a ready market, condensate fractionation (if neccesary) ensure that none of the international plays are worth much today even if they are proven to be economic (and I am not aware of any that have, but I'm sure some will be, particularly in Poland).
     
    When you say the "group as a whole has 30 years of organic drilling inventory", you are talking about the shale peer group I mention about (which is rapidly being privatized at high values).  APA, APC, DVN etc absolutely do no have 30 years of inventory for mainenance drilling, much less production growth (like CHK, RRC, XTO, UPL, KWK, XCO, HK etc.)
     
    I don't think RRC is trading at a "100% premium to the private market value" . . . I think its market cap accurately reflects the value of RRC's Tier 1 acreage (and 60% of CHK's acreage).  Tier 1 Marcellus acreage is the highest rate of return gas shale in the country, with a breakeven of $2-$3 mcf depending on if its in the "dry" northeast or "wet" southwest sweet spot.  RRC and CHK have the biggest footprint here and their rates of return rival oil/liquids plays anywhere else in the county.  When you consider (as the majors clearly have) that natural gas will not hover around $4 for much longer, the value of this acreage is very large, and I believe accurately reflected in RRC's market cap. 
     
    Knowing how many days it takes to drill and frac a well, how much it costs, how many you can do a year and what the current (or future) price of gas is, owning a shale play is like owning a bond (albeit one where you have to pay "coupons" or drilling cost as well as recieve coupons in the form of revenues from your wells).  By making basic assumptions you can model these plays and decide exactly what the land is worth today based on your required rate of return.  This is exactly what the majors are doing, and they are buying at what I believe are 15-20% return assumptions under conservative pricing scenerios.  I don't think RRC will be bought out a premium to its current price unless gas rises, but I think the current price probably reflects a 15% IRR to the buyer who keeps drilling (with upside to higher gas prices). 

    SubjectRE: reply to dr123
    Entry10/25/2011 07:15 PM
    Memberdr123

    “I don't think you can ignore fifteen or so multi-billion dollar purchases (with the oil majors as the usual purchasers) of shale assets in the US.  Looking at RRC, HK (bought out), XTO (bought out), XCO (management attempted to buy out), KWK (management attempted to buy out), BEXP (bought out) and a number of asset sales, there is clearly something unique about having "huge tracts of land" if it is in the right place.  Exxon, Shell, Total and the other majors have bet more than $100 billion on it.”

    Perhaps we should all buy SPWRA given Total’s interest in this area and the amazing discount of shares to their private market value.  Humor aside, I think you are very right in focusing on the “tracts of land” being in the right place.  “huge” tracts almost by definition rarely are.  I don’t think any of the transactions cited are directly applicable to CHK’s value today:
        RRC – Will see.  Private market for more digestible chunks of core Marcellus acreage is <<$10K/acre and has been trending down in price and the number of transactions since 2010 as new and exciting plays have popped up.
        HK – Not sure this is relevant to gassy assets.  Perfectly reasonable deal even using $4/Mcf gas in perpetuity.  Their Black Hawk acreage could be worth >>$100,00/acre developed @ $90/bbl WTI.  Given that HK had arguably the best Eagleford acreage it is very unclear what, if anything, was paid for Marcellus and even Eagleford stuff outside of the condensate window.  I have no beef with the value of Eagleford condensate acreage at current oil prices.
        XTO – At the time this was hailed as a wise purchase at the bottom of the market and a sign of the impeding recovery in the natural gas market.  A little less than two years later the 5-yr HH futures are down another ~$2/Mcf.  Most likely XOM has lost money on that one and in retrospect the ensuing excitement was a great opportunity to short the group and probably the best time for CHK to get sold.
        XCO, KWK – Could be an indication that the glut of resource plays is more broadly appreciated.  Especially a KWK buy-out could probably be justified using $6.00/Mcf long-term assumptions and may make far more sense than RRC.
        BEXP – Similarly to HK, I am not sure this is relevant to gassy assets.  Though given the implied oil price of >$120/bbl the consideration was eye-opening.
    I agree that there is continued appetite for concentrated acreage in oil plays.  I’m just not sure how relevant this is to gassier plays or players with such huge acreage that development can’t plausibly be accelerated by a better-capitalized player.

    BTW, one could argue that majors are not the best judges of long-term economic value.  They are the same guys that left US onshore just as it was the time to invest over a decade ago.  Anecdotally, some didn’t believe the whole “shale thing that the kinds are doing these days” until recently using $6-7/Mcf as the marginal cost of US NG supply in their long-term planning.


    “As for international shales, there is no infrastructure so none of them will be developed to a meaningful degree in the next ten years.”

    Your own write-up seems to be in disagreement stating: “shale is the source rock for conventional oil and gas pools, and it only exists where there has been conventional production for years”.  This is certainly the case for Neuquen – the basin I am most familiar with.  Following the decline in conventional production there’s ample spare capacity in the value chain – similar to Texas and superior to Appalachia from the infrastructure perspective.


    “When you say the "group as a whole has 30 years of organic drilling inventory", you are talking about the shale peer group I mention about (which is rapidly being privatized at high values).  APA, APC, DVN etc absolutely do no have 30 years of inventory for mainenance drilling, much less production growth (like CHK, RRC, XTO, UPL, KWK, XCO, HK etc.)”

    As long as the industry as a whole has say 40 years of inventory it may not matter much how it is distributed – the average acre will still not get drilled for a while.  Back in late 2010 IHS CERA report I have saved estimated that ~900Tcf (~40yrs of supply) in North American resource plays that is economic to develop at <$4.00/Mcf and ~200Tcf (~10yrs of supply) is economic <$3.00/Mcf.  I’ve seen similar magnitude of figures elsewhere though costs vary depending of the level of skepticism over the current reserve booking practices of the shale folks.  The CERA report was before Duvernay.  May have included Utica.  I think it is fair to say that the “average” low-cost (defined as <$4.00/Mcf break-even) acre is not getting drilled for a couple of decades – hence the earlier comparison to the Florida real estate.

    “owning a shale play is like owning a bond (albeit one where you have to pay "coupons" or drilling cost as well as receive coupons in the form of revenues from your wells).  By making basic assumptions you can model these plays and decide exactly what the land is worth today based on your required rate of return.“

    This assumes the absence of infrastructure constraints and infinite end-market demand, among other things.  Problems occur when pipelines, liquefaction/GTL/NGV infrastructure, and chemical capacity need to be built to absorb incremental supply while the existing product market is already saturated.  Classical economics predicts that prices should come down to the marginal cost of developing the lowest-cost acreage and after all of that gets drilled out move up along the supply curve as development expands out of the core to higher-cost resources.  At best, the industry will strive to earn its cost of capital.  This seems to be exactly the scenario playing out.  So a better analogy may be having a large stash of such bonds but only getting paid on a small fraction at a time at a rate that is dependent on how many other folks have similar bonds and are trying to cash them in.
     


    SubjectRE: Re JV's
    Entry10/28/2011 02:18 PM
    Memberdr123
    Here’s one way to spin the analogy of the pot of gold that does not require the majors to be irrational and comes down to simple math.   (Note that this applies to dry-ish NG resources only):
    - Assume the industry reserve bookings are correct.
    - If one aggregates all the plays and their estimated recoverable resources one ends up with approximately 40 years of inventory at current consumption rate (plenty of studies by CERA and others supporting these figures).  The studies I have are about a year old so the inventory has since grown.  Of course consumption will likely grow above the historic trend given all the efforts to boost it so let’s call this a wash, the difference is not material to the conclusion.
    - Assume this inventory has super-low-risk bond characteristics given the predictable drilling nature that justifies 5% _real_ discount rate and that we precisely know the NPV of drilling.
    - Take two identical acres:  one to be drilled in year 0 of the program, one in the last year.  The second acre will be worth approximately 14% of the value of the first – two parts of the proverbial pot.  At 10% real discount rate one gets the second acre worth ~2% of the value of the first one.

    This seems like a pretty obvious an unemotional observation.  As long as the industry has decades of inventory it is necessarily the case that (assuming these can be profitably developed) actual economic value varies by 5-10-20x from acre to otherwise identical acre depending on where in the development queue each is.

    This is precisely why a takeout of someone like HK, COG, or any of the other small guy with very concentrated low-cost asset makes economic sense but a takeout of RRC or CHK is much harder to make work.  Note that with each takeout the value of the remaining guys’ acreage actually drops as their acreage gets pushed further out on the industry queue as the acquired acreage is pulled forward.

    I would appreciate any holes one can poke in the above argument.  The above assumes the industry acts perfectly rationally and only drills when they can generate positive IRR.  Judging by the current direction of the NG rig count, this may be a very generous assumption...

    The only "recent" transaction that seems in disagreement with the above observations was XOM’s purchase of XTO.  Given the subsequent strip performance it seems pretty clear that that if it was a bet on the commodity price, it was wrong.  My sense from talking to the industry is that this may have been put together over a year or two (as these deals often are) based on the '07-'08 industry cost assumptions (the marginal NG supply coming from GOM).  A further point made was that it may have had less to do less with the value of acreage than with buying a team to throw at US and international unconventional opportunities.  Many of the international players are also likely just looking to learn how to do shales in the US before doing so at home and are “paying tuition” instead of valuing the resource.

    SubjectAubrey to buy oil play?
    Entry10/28/2011 08:53 PM
    Memberad188
    notice Aubrey's dialgue lately, tilting towards unconventional oil? it makes sense for CHK to buy something in oil, with real cash flow, like Pioneer, especially if Aubrey can use his shares ... so maybe the hyper promotion of the Utica is only to finance the next deal, for oil

    Subjectchk utica jv
    Entry11/03/2011 04:10 PM
    Membersugar
     

    OKLAHOMA CITY--(BUSINESS WIRE)-- Chesapeake Energy Corporation (NYSE:CHK - News) today announced two transactions to monetize a portion of its 1.5 million net acres of leasehold in the Utica Shale play primarily in eastern Ohio. Fully implemented, the transactions would result in consideration to Chesapeake of approximately $3.4 billion.

     

     

    Chesapeake has entered into a letter of intent (“LOI”) with an undisclosed international major energy company for an industry joint venture (“JV”) through which the JV partner will acquire an undivided 25% interest in approximately 650,000 net acres of leasehold in the wet natural gas area of the Utica Shale play. Of this acreage, approximately 570,000 net acres are owned by Chesapeake, and approximately 80,000 net acres are owned by Houston-based EnerVest, Ltd. and its affiliates (“EnerVest”). The JV area covers all or a portion of 10 counties in eastern Ohio (the “JV AMI”). The consideration for the transaction will be $15,000 per net acre, or approximately $2.14 billion to Chesapeake and approximately $300 million to EnerVest. Approximately $640 million of the consideration to Chesapeake will be paid in cash at closing, and approximately $1.5 billion will be paid in the form of a drilling and completion cost carry, which Chesapeake anticipates fully receiving by year-end 2014.

     

     

    Chesapeake will serve as the operator of the JV and will conduct all leasing, drilling, completion, operations and marketing activities for the project. The LOI provides that the JV partner will have the option to acquire a 25% share of all additional acreage acquired by Chesapeake in the JV AMI and the option to participate with Chesapeake for a 25% interest in midstream infrastructure related to production generated from the assets. The LOI provides for the execution of definitive transaction documents and closing by mid-December 2011.

     

     

    Additionally, as a first step in a financial transaction led by EIG Global Energy Partners (“EIG”), Chesapeake has completed the sale to EIG of $500 million of perpetual preferred shares of a newly formed entity, CHK Utica, L.L.C. Chesapeake expects to sell up to $750 million of additional CHK Utica preferred shares to other investors, including limited partners of EIG, by November 30, 2011. CHK Utica is a wholly owned, unrestricted subsidiary of Chesapeake that owns approximately 700,000 net leasehold acres within an area of mutual interest in the Utica Shale play in 13 counties primarily in eastern Ohio (the “CHKU AMI”) that encompasses the JV AMI. Chesapeake has retained all the common interests in CHK Utica.

     

     

    The CHK Utica preferred shares are entitled to receive an initial annual distribution of 7%, payable quarterly. Chesapeake retains an option exercisable prior to October 31, 2018 to repurchase the preferred shares for cash in whole or in part at any time at a valuation expected to equal the greater of a 10% internal rate of return or a return on investment of 1.4x. Assuming a total of $1.25 billion of CHK Utica preferred shares are purchased, investors in CHK Utica preferred shares will also receive a 3% overriding royalty interest in the first 1,500 net wells drilled on CHK Utica’s leasehold, which is the equivalent of an approximate 0.45% overriding royalty interest across Chesapeake’s projected 10,000 net well inventory. Chesapeake’s average net revenue interest on its Utica Shale leasehold is approximately 83%, which compares favorably to net revenue interests in the Haynesville, Barnett and Eagle Ford shale plays of approximately 75%.

     

     

    As part of the financial transaction, Chesapeake has committed to drill a minimum of 50 net wells per year through 2016 in the CHKU AMI, up to a minimum cumulative total of 250 net wells, for the benefit of CHK Utica. Chesapeake believes it will have considerable operating and financial flexibility in fulfilling the drilling commitment because the company’s planned Utica Shale drilling program for the years ahead involves a significantly higher rig count than the approximate 10-rig drilling program required by the terms of the CHK Utica preferred shares investment.

     

     

    Jefferies & Company, Inc. is acting as financial advisor to Chesapeake on the JV.

     

     

    Management Comment

     

     

    Aubrey K. McClendon, Chesapeake’s Chief Executive Officer, commented, “We are pleased to announce the signing of an LOI for our industry JV in the Utica Shale and also the closing of the $500 million initial investment by the EIG-led investor group. Through the industry JV, we will be able to recover more than our total leasehold investment in the entire Utica Shale play while only selling approximately 142,500 net acres of our 1.5 million net acres of Utica Shale leasehold. Through the financial transaction led by EIG, our drilling program in CHK Utica is almost entirely funded for the foreseeable future (including cash flow from anticipated production). We have achieved very strong initial drilling results in the wet natural gas and dry natural gas areas of our Utica Shale play and are beginning to accelerate our evaluation of the oil area of the play, which the EIG transaction will help enable.”

     

     

     


    SubjectRE: chk utica jv
    Entry11/04/2011 10:17 AM
    Memberdr123

    The recent Utica results, if confirmed and representative of a material portion of the condensate window, would indeed indicate a very substantial value for the Utica acreage, largely independent of the NG price.  Congrats to Aubrey!  But wouldn’t such confirmation also substantially reduce the “fundamental” value of Marcellus acreage specifically and all NA dry-ish resources in general by introducing another large source of associated gas supply into an already oversupplied market, presumably at a far lower breakeven than even the best dry Marcellus?

    Interestingly, a recent study by CERA tried to explain why the gas rig count has re-started growing in spite of the short-term strip being below the generally believed levels of the marginal cost of new supply.  When the study analyzed the liquids component of the production of NG wells drilled in 2011, it arrived at a weighted-average breakeven price <$3.00/Mcf vs. their previously estimated breakeven >$5.00/Mcf (for subscribers, see the recent IHS CERA NA NG Day presentation).  I wonder what this will look like if/when Utica ramps up...

    It would appear that at these levels of the marginal cost of new supply and with an impeding flow of liquids out of Utica pretty much every Marcellus name is a short on a fundamental level, perhaps not tactically given the takeout risks for the smaller guys, but certainly not longs.  How is the condensate window of Utica (if the data holds up) not a Long-term disaster for the Marcellus folks (and many others)?  Am I missing something?


    SubjectRE: RE: RE: Q
    Entry11/14/2011 10:26 PM
    Membersugar
    Its incredible to me that CHK is running so many rigs still drilling for dry gas. They can't be generating sufficiently high returns in any of their dry gas plays to justify drilling anywhere they aren't either holding core acreage by production or getting carried by JV dollars.

    SubjectCorrupt
    Entry11/24/2011 11:38 PM
    Memberjaxson905
    Chesapeake is a very corrupt organization.  I disagree with the view that these JVs necessarily create value - what Aubrey shows you is that he bought land for say $1 billion and sold 25% for $1.5b which implies 6x his money.  But the problem is he doesn't tell you about the $5 billion he spent buying scrubbrush, but you'll see it if you look at his cash flow statement and ROIC.  I equate it to a guy who spends $10 on slots and finally one of his $1 bets hits and he gets $6 back - he then tells you he made 6x his money in slots. 
     
    The reason I say corrupt is that this poor capital allocation is driven by his compensation agreement.  He gets to personally participate in 1% of all the companies capex (the "Founder's well program").  But here's the catch - its only on acreage they drill and when they do drill he gets to buy the acreage at book value.  So what Aubrey does is he finds a new play (like the Eagleford you mention), pulls out the company's check book and unloads it on large blocks of acreage around the play.  80% of what he spends is a write-off and 20% is prime.  He then drills wells on the prime acreage and gets to personally invest at book value.  So say he buys 1mm acres for $2,000/acre on average ($2 billion).  800k of it isn't poor, 200k is prime acreage that will be worth $10-15k/acre.  CHK will drill that and he'll get to invest personally at $2k/acre when it's worth $10-15k.  He doesn't have to invest in the 800k.  It's all very corrupt, it took me a while to figure it out. 
     
    Good luck partnering with him.  Despite all the big headline numbers and promotion, the stock has really gone no where for years and I think the market is increasingly wise to the corporate governance issues here as well as the real story on capital allocation. 
     
    Keep in mind too the hedge book is a complete black box and really distorts the accounting. 
     
     

    SubjectRE: RE: Corrupt
    Entry11/29/2011 09:06 PM
    Memberjaxson905
    The disconnect is b/c you are looking at the cash flow statement which shows proved and unproved acquistions/sales and reports them commingled.
     
    If you go to page p 13 of the 10-K you get the following numbers for unproved (i.e. acreage) acq/sales:
     
                   Acquisition           Sale               Net
    2010            -7.0b                +1.5             -5.5b
    2009            -2.8b                +1.3             -1.5b
    2008            -8.3b                +5.3             -3.0b
    2007            -2.5b                +0.0             -2.5b
     
    Gross acreage investment: $20.6b
    Net acreage investment:  -12.5b
     
    He's sunk $21 billion into acreage and $12.5b net of proceeds from sales.  That's an astoundingly large amount.
     
    Also I'd encourage you to look carefully at the hedge book through time - it is a total black box.  I remember doing my first deep dive on this name in 2009 and noticing that they were basically unhedged on nat gas in 2010.  Then somehow magically they become hedged with swaps that were well above market.  It turned out that they were doing was writing call options on oil and natural gas (and in the case of nat gas they were very long dated options, some stretching out to 2020) and using the proceeds to buy their way into an attractive hedge position for the next year so their EBITDA would not fall materially.  I personally viewed that as very troubling. 
     
    On the compensation agreement and the founder's well program, it's all laid out in the proxy.  I originally wanted to like this deal - what's not to like about a CEO who is willing to put his personal money beside the company's on all their capex decisions? (I wish most companies had that deal, we'd all be a lot better off).  However it took me a while to realize the nefarious side of it - it's only for capital spent drilling wells, and when they do drill a well the CEO only has to pay for the land acquisition costs at book.  This totally explains the behavior of the company - spend $21 billion buying acreage, so you can buy your way into each and every attractive shale play.  A good portion of it is worthless but you'll definitely own some of the core acreage when you do that.  Then drill the core and Aubrey gets to buy that piece of it at cost (which is unfair b/c its immediately worth a big premium to cost, so the value is being directly transferred to him), but takes no loss on the billions spent all around that that will inevitably be written off (like in Q1 or Q2 2009 when they took that $9 billion charge for uneconomic acreage).  This is where he makes all his real money.  The egregious compensation that is reported annually by the WSJ is really just a sideshow. 
     
    I know this one quite well, have followed the company closely for years.  He's very talented but also quite corrupt, so just make sure you're comfortable with that as part of your investment thesis. 

    SubjectUtah, dr, others, any thoughts?
    Entry01/03/2012 10:14 AM
    Membertyler939
    Any thoughts on today's announcements and its implications for the gassy names would be appreciated.

    SubjectRE: Utah, dr, others, any thoughts?
    Entry01/03/2012 04:21 PM
    Memberdr123

    Assuming no infrastructure constraints, it seems that the liquids-rich cores of plays like Eagleford, Utica, and Duvernay should work regardless of the NG price.  So every incremental multi-$billion JV targeting these resources pushes out even the lowest-cost dry NG resources further out along the supply curve.  Specifically, yet more capital and more drilling yielding NG as a by-product in an infrastructure-constrained area seems particularly bearish for the dry-ish Marcellus names.



    SubjectRE: RE: Utah, dr, others, any thoughts?
    Entry01/04/2012 02:15 PM
    Membertyler939
    At the risk of asking a stupid question, does anyone think that this and the other recent jvs are symptomatic of a problem at Total other than poor capital allocation?  When they bought their stake in SPWR, I thought it was mainly for public relations purposes ("we are a clean energy company").  Now with their additional acquisitions, I am wondering if there may be more here than meets the eye. 

    SubjectRE: RE: RE: Utah, dr, others, any thoughts?
    Entry01/04/2012 02:57 PM
    Memberjohn771
    Total's investments only make sense if oil remains scarce and high priced.  This article explains the CEO's outlook:
     
    http://www.forbes.com/forbes/2011/0214/features-christophe-de-margerie-total-high-friends-low-places.html
     

    SubjectRE: figure you guys are on top of this...
    Entry01/11/2012 01:00 PM
    Memberdr123

    This brings up the general topic of the recent epidemic of “value creation” by E&Ps through spinning off midstream assets into separate yield vehicles.  This was bound to end in tears for some of the deals, probably sooner rather than later.  Unfortunately, we do not have the bandwidth to build the expertise necessary to find the upcoming blowups...  Any perspectives on this topic would be greatly appreciated.



    SubjectRE: RE: figure you guys are on top of this...
    Entry01/11/2012 02:55 PM
    Membersugar
    GMXR experienced this, their midstream deal is partly why they continued to drill incredibly uneconomic Haynesville wells in 2010.
     
    GMXR is almost certainly going bankrupt in the next year. Which makes me think of a much larger, highly levered natural gas producer with similarly challenged deals. Perhaps it is time to revist Cheseapeake as a short candidate. What natural gas price will it take over what period of time to bankrupt CHK?
     
    I think XCO could also be getting themselves in trouble here, with their midstream deal, relatively unhedged production, and almost 100% gas production. Yes, there are billionaires backing them, but no, billionaires don't like to lose money and have been shown to step away from insolvent gas producers (look at delta petroleum).
     
    COG and RRC have traded at growth multiples despite their natural gas exposure, perhaps their stocks get whacked here too with sub $3 natural gas prices, even if they aren't likely to actually go bankrupt.

    SubjectRE: RE: RE: figure you guys are on top of this...
    Entry01/11/2012 03:41 PM
    Memberdr123
    Sugar, I agree with all of your points.  Despite our deep suspicion of the CHK long thesis and shale math for the industry with decades of drilling inventory, we remain reluctant to short it given how “cheap” it looks relative to say RRC with much of the undeveloped resource offering materially superior economics to RRC’s Marcellus.  CHK’s buried bodies seemed too hard to appropriately value so we opted for the simplicity of shorting more expensive names without the discount for the “hair” (or, even better, with billionaire premiums) – this may have been a mistake given CHK’s subsequent performance.

    It seems that the next step may be shorting midstream trusts/MLPs that will be affected by NG production curtailments and/or producer bankruptcies as the industry seems to be finally running out of luck.  As these tend to be owned by yield-focused investors they typically trade relative to the fixed income substitutes up until the distributions get whacked and then experience a double-whammy of falling distribution and raising yield.  Perhaps now is the time to start work on this group?


    SubjectRE: RE: RE: RE: RE: RE: figure you guys are...
    Entry01/23/2012 02:12 PM
    Membersugar
    CHK should be up because they're making 2 major changes the market has wanted them to make for a while.
     
    First, they're shifting drilling activity away from dry gas. 1 rig in the Hayensville represents roughly $120 mm in capex overall ($10 mm per well, 12 wells drilled per year, including fracking and other non drilling costs). They were generating negative returns on that capital employed, and are shifting it to positive return activities. 23 rigs less means more effectively deploying $2.7 billion (probably less since they don't own 100% working interests), which is huge considering CHK's size and financial situation.
     
    Second, they have guided to substantially reduced leasing costs, 100% of which will be in existing basins/plays. They are at least claiming to have ended/suspended the leasing machine, which many were concerned would drive them off a cliff if dumb money stopped funding overpriced JVs.
     
    I totally agree regarding ECA. I look at that company and just cannot begin to understand what management is thinking. They have HUGE Cardium and other oily unconventional exposure in Canada, and yet they're so worried about the sunk cost of Haynesville leases or the negative optics of shriking production that they won't shift drastically cut dry gas capex and shift it to highly economic oil or liquids plays.

    SubjectSugar
    Entry01/23/2012 02:21 PM
    Membertyler939
    With regard to ECA, what makes you think that they aren't reconsidering their mix now that CHK has made the first move (and is there any reason this would not be viewed as a positive)? 

    SubjectRE: RE: RE: RE: RE: RE: RE: figure you guys are...
    Entry01/23/2012 04:38 PM
    Membersugar
    Utah,
     
    Can you please substantiate your extremely bearish NGL claims? They remind me of what people were saying a year and a half ago (except the people talking about it then actually referenced data) and they were way off- with $100 oil, there was tremendous capacity to use NGLs (other than ethane) to replace refined oil products in a highly economic fashion. What, in your view, has changed?

    Subjectfor Utah...
    Entry01/24/2012 08:21 AM
    Memberlordbeaverbrook
    Utah,
     
    I reviewed your CHK write-up recently; my compliments on your prescience. You were proved very right with  time. 
     
    My reading is that a key tenet in your thinking at the time was that the top-down industry expectations (in 2009) was a decline in production, while the publics together were all saying to their investors they were going to grow production. The two were impossible without silly privates assumptions, and the latter was more likely to take place - which is what happened.
     
    Are you continuing to follow the industry in a similar fashion?  Is the situation similar in spite of natural gas price being half of what it was earlier? I am very curious how the publics will change their production growth expectations over the next six months as $2 gas settles in.  

    SubjectCHK: shutting in cash flow
    Entry02/09/2012 03:58 PM
    Memberutah1009
    Aubrey's cabana boy was at the CSFB conference today and said that CHK has actually shut-in a higher amount of gas than the previously announced 500 mmcf/d, which has the nat gas market all excited.  First of all, this is stupid because I believe that all of the gas that they're shutting in is economic at $2.50 (and lower) prices.  The lifting cost is very low, and transportation is at most $1.00.  CHK is literally passing up on $175-225m in annual cash flow because they like how a press release sounds.  
     
    Second, for those not paying attention, you must be saying to yourself, "Self!  If gas is at $2.50 and CHK, as the country's second largest gas producer is announcing shut-ins, surely other large gas producers must be acting similarly?"  And then I would tell you, "Psych!  Conoco said they haven't shut anything in and even if they do, it wont be more than a measely 100 mmcf/d.  Exxon, the largest producer in the US, hasn't either, nor do they plan on it.  Chevron?  No.  Devon?  No.  Anadarko?  No.  BP?  No.  Shall I continue?"  Funny, eh?
     
    The most ironic thing in all this is that CHK, by prematurely shutting-in production (isn't it normally premature blow-outs?  Thanks folks, I'll be here all night!) is just ensuring that the rest of the industry is slower to respond.  CHK is incentivizing the industry to not curtail production.

    SubjectRE: CHK: shutting in cash flow
    Entry02/09/2012 04:11 PM
    Membersugar
    Utah - maybe I'm giving Aubrey too much credit here, but maybe he went around to meet with other E&P CEOs to collude on reducing supply. That conversation goes as follows "You want me to do what? Shut your own production in first and then we'll talk"
     
    Another possibility is that he truly believes natural gas prices are at a low point - if he can wait a year and sell his gas for 50% more money, maybe its the right economic decision.
     
    And one final thought - maybe this is a way of signalling that CHK is totally fine, has no liquidity issues, and can afford to voluntarily reduce cash flow.
     
    I think you made some good points, but perhaps it makes sense to consider the above for a fuller possibility set/context.

    SubjectRE: CHK: shutting in cash flow
    Entry02/09/2012 04:33 PM
    Memberdr123
    Perhaps I’m making an obvious observation, but shutting down production doesn’t really do much to support the medium-to-long-term prices either.  There are enough uncompleted wells acting as virtual storage already and adding shut-in wells on top of that just creates a ceiling for the commodity price and delays the eventual recovery once the investors stop rewarding these guys for growing off the cliff and the “NG rig count” (strictly speaking there are few/none pure NG and oil rigs these days) reaches something more sensible given the current oil rig count, say ~400.

    From the department of interesting purely speculative possibilities:  Maybe CHK has finally ran out of luck day-trading, I mean “hedging”, their commodity exposure and is caught with a speculative long NG position that they are trying to juice, sacrificing cash flow in the interim but avoiding a margin call.


    Subjectso is there an optimal hedge?
    Entry02/10/2012 02:21 AM
    Membertyler939
    Reading the past few comments, whether Aubrey is "signaling" or whether this is stealth collusion or whether CHK is stuck with a spec long position (it would have to be big enough to be a major risk to the company), it seems to me that there should be an optimal long term hedging strategy (putting aside the day to day noise of irrational price movements in individual names) for a short chk position .  Any suggestions?  Obviously, you could buy nat gas futures which works as hedge if natural gas makes a sharp move higher, but the risks are too high to make it an optimal hedge.  On the commodity side, I am thinking of option strategies on nat gas (I am assuming, hopefully correctly, that there is little chance of a major price increase in natural gas), so selling volatility or downside puts  or put spreads seems right.  On the stock side, which non small caps (Sugar, I consider your recent suggestions to be stand alone investments, not hedges), are most unlikely to cut production and therefor benefit from the collusion possibility, or are currently under pressure due to fears of another sharp decline in nat gas but would really do well if the market was assured that the bottom for nat gas was really in?  Alternatively, am I over thinking all this and should leave it to the quant shops to figure out?

    SubjectPossible Sale of Permian Asset
    Entry02/13/2012 10:00 AM
    Memberncs590
    from the release:
     
    "Chesapeake has also recently received industry inquiries about a complete exit from the Permian Basin and today is announcing that it may consider a 100% sale of its Permian Basin assets if it receives a compelling offer."
     
    I think their Permian acreage (which as per the release is now 1.5 million acres).  I value 60% of the 830k acres they previously owned at $20k (less than the value per acre CXO trades for), and the rest of the acreage at $1k per acre.  This is obviously not an exact science, but I am pretty confident that this $9.4 billion guesstimate will be in the ballpark if they sell.
     
    This sale would take care of all of CHK's current financial problems and would make a lot of sense (I have previously suggested to the company that they sell this large, unecumbered, well understood oil asset, but didn't have much hope they would do so until the current cash crunch)
     
    There are a number of large well funded competitors operating in the area that could afford a $10 billion pricetag.  I think this asset sale is something of a failsafe, if all else fails I'm sure they can sell it for at least $5 billion, but if they can get $10 billion or more, I think it is a game-changer.  Share buybacks would be a legitimate possibility later this year at that valuation (I won't hold my breath).  At a minimum, this sale would get investors focused on the value of the assets again, just as the Fayetteville sale did a year ago (when the stock ran from $21 to $36)
     

    SubjectRE: RE: Possible Sale of Permian Asset
    Entry02/13/2012 11:09 AM
    Memberncs590
    Teton, to want to own CHK I think you have to believe that gas-shale and then oil-shale (in which I include carbonates like the Mississippi) have been game changers in the industry and that its been worth levering up and being stretched to get their hands on as much of these assets as possible.  If you don't believe that, then CHK is just an empire builder that is over-promising like ATPG.  I believe the former.
     
    The fact that almost all the land CHK has bought (with the exeption of the Antrim in Michigan and likely the Williston acreage they bought) is still worth a lot more in this depressed environment than it was when they bought is strong evidence to me that CHK was right to stretch to buy the acreage when they did. 
     
    I think my valuation of the gas assets above is a little high in this environment, but giving them a $10 billion haircut still puts the value of the company at over $50 per share today. 
     
    I think the sale (or lack theirof) of the Permian assets will settle this issue once and for all.  I had thought the sale of the Fayetteville took care of this issue, but then the oil shale rush took off again.  I think the values I use above are valid, and confirmed numerous times.  I think this is exactly what shareholders will get.  I believe investors are just focused on the short term funding issues instead of these values right now.  If you gave me a $10 billion funding gap and $50 billion in saleable assets, I think I would walk away with $40 billion in value one way or another. 

    SubjectRE: RE: RE: Possible Sale of Permian Asset
    Entry02/13/2012 11:21 AM
    Memberjso1123
    ncs - i know this company reasonably well and the only caution i would give you is that the management is not being honest with you when they say that all the land they bought has been mutiples of their money invested.  They always show you the gains on the minority positions they sell but now the economics on their total land investment.  You've probably spoken to the same landmen that i have spoken to over the years so know how they operate - they come into regions and bleed cash and pay huge premiums to buy everything that is available and often do that before the geology is really understand.  they end up writing off the majority of that down the road but show us the minority portion that has been multiples of their investment (see post by jaxson below). 
     
    also why is CHK selling their oil assets now?  those were supposedly the crown jewels and the future of the company (giving that it levered up for years investing in the gas "land grab" that has turned out poorly)?  It feels desperate given that their focus has been on growing oil production.
     
    also don't forget about all of the off-balance sheet liabilities which are intense here - VPPs are just sale-leasebacks, they aren't asset sales and it's disingenuous for CHK to call them that (which they do). 
     
     
     

    SubjectRE: RE: RE: RE: Possible Sale of Permian Asset
    Entry02/13/2012 11:38 AM
    Memberncs590
    Biffins, I think the natgas strip is low and that prices are likely to be higher than the strip suggests in the next few years (but could get very bad this year!).  Why do you think they will stay low for so long?  If the Marcellus and the associated gas from oil/liquids wells is the only thing economic at $3, where do you expect the production to come from in 2013?
     
    JSO, I don't disagree on the land, but I think they buy a huge amount for a small price per acre, sell a portion of the total (or just of the best part) for an amount equal to their entire outlay, and then eventually a good amount turns out to be marginal.  I think I take this into account in my valuation by giving 40% haircuts to some of their land positions.  I also think this is consistent with my contention that their net price for acquired land (and likely their gross or pre-JV price) is still below what it would cost today.  Also, I cover the VPP's in my valuation above, and they are definately not debt and have no recourse to the company beyond the 20% of those wellbores that CHK still owns.

    SubjectRE: RE: RE: RE: RE: Possible Sale of Permian Asset
    Entry02/13/2012 06:27 PM
    Memberdr123
    Ncs, Do you have a sense of the production-weighted average cost of NG supply from 2011 drilling?

    Marcellus and associated gas are most likely not the only sources of NG supply economic ~$3.00/Mcf.  To look at this from a liquids yield perspective:  Assume you have an “average” play that has $5.00/Mcf breakeven in the dry gas window and a (relatively benign) 20bbl/Mmcf or 12% oil and liquids yield in the wet window with the blended average pricing of $80/bbl.  This is ~$1.00/Mcf credit pushing your breakeven to $4.00/Mcf in the wet window.  20-30% liquids yields are not uncommon though admittedly liquids prices should continue to converge to NG so the credit is shrinking.  Away from the two small “ultra-cores” Marcellus core appears to have ~$4.00/Mcf breakeven.  To name a few, areas of Granite Wash, Eagleford, Miss., Barnett Combo, and WCSB liquid-rich plays-of-the-month show comparable/lower costs.

    At ~$4.50/Mcf Jan 2015 HH seems pretty efficiently priced though our concern is that it might still be a bit too rich given the 2011 cost of supply and the continued trend of cost deflation.  It is shocking that it was trading as high as ~$6.00/Mcf a year ago.


    Subjectshale economics
    Entry02/13/2012 07:17 PM
    Memberncs590
    dr123,
     
    I don't have an exact answer for you.  Range Resources gave a presenation on January 10th which has a table from Goldman (dated May 31, 2011) showing the breakeven for each dry gas play.  In Range's February presentation this is replaced with less useful tables showing RoRs for different plays using the strip from four months ago.  I don't know what type of oil deck goldman is using to make these calculations, but they clearly don't think there is much gas that breaks even below $5.00
     
    I think you are suggesting that the gas component of liquids plays will push the cost curve out so much that we don't need to drill plays that break even at $5 dollars.  I think there aren't enough rigs and frac crews in existence to make this a reality by 2015.  If you look at slide 17 of Contango's latest power point you can see the current production from the big five shale plays.  The Barnett and Fayetteville have probably already peaked and will start to decline (in terms of production) and I expect the Haynesville to peak and start to decline in the second half of this year.  The legacy production in newer plays like the Haynesville is heavily weighted to the most recent year's vintage, so I think you will see decline rates of legacy production in these shales of 50% (which will be partially replaced by new production, new hook-ups and completions).  These five shale plays account for 18 Bcf/day of production.  The Marcellus and Eagle Ford will continue to grow, but it won't make up for the decline in the Haynesville, Fayetteville and Barnett (much less the non-Cana Woodford which is already in decline).  Even if the liquids plays can keep up this, shale gas is only 30% of US production, the other 70% is legacy conventional production, which is declining at ~10% per year.  This means that we need to grow total shale production by about 23% in 2012 and 17% in 2013 in order to increase the total shale contribution to US production to 37% by the end of 2012 and 43% by the end of 2013 . . . the more shale production we have, the more we lose each year (roughly 50% of last year's production).
     
    I don't see any way to maintain this type of growth or even come close without growing or at least maintaining production in all of the above mentioned fields.  If you don't think gas is above $4.50 by 2015, I suggest you agressively short SWN because it is worthless and there will be no more drilling in the Fayettevillle.  Frankly, I don't think we could keep up at $5 gas and I expect another spike by 2015/2016, because once we have worked out way back through all the coal switching (there will be a number of coal plants coming offline), it will take just as long to ramp production in the Haynesville back up as it did for it to ramp down and slowly fall off (i.e. 12-24 months). 
     
    The same size well using the same type of rig in the Eagle Ford only produces about a third of the gas that a rig in the Haynesville would.  I don't have exact figures, but I bet you would have to double the unconventional oil rig count to keep prices above $5 - and it is at a record today.

    SubjectRE: shale economics
    Entry02/14/2012 12:56 PM
    Memberdr123

    Ncs,

    I would urge you to base your industry cost analysis on independent consulting shops or run your own numbers on the production data reported from the various plays.  I’m not sure why one would expect Goldman’s work on NG supply to be any less influenced by their interest in selling equity of NG producers than their work on say mortgage debt.  Same holds for producers’ investment presentations.  I’ve been to industry panels with no financial industry presence where the $3-4/Mcf breakeven figures go completely unchallenged by the same E&P folks who then go back to the office to write the presentations you cite.

    I’ll avoid wondering into the weeds of further cost-of-supply discussion.  I’ve done my work on the breakeven cost of a number of plays and seen some good independent research on the breakeven cost of 2010 and 2011 vintage wells and very much hope the consensus comes to share the same sell-side and company’s arguments as you supply.  My financial interests are best-served by leaving these unchallenged…

    Re SWN:  It was one of our largest short positions in this sector in 2011 but we do not see substantial downside <$30/sh where the name seems to be pricing-in a more reasonable ~$4.00-4.50/Mcf in perpetuity while plenty of more expensive shorts abound.
     


    SubjectRE: Oh dear
    Entry04/18/2012 01:16 PM
    Membertyler939
    So what happens now?  Reuters reported that EIG sweeps all of the cash flow from the interests that McClendon pledged, and gets a 13% return on their investment, plus 42% of all cash flow above that.  This seems like a great deal for EIG, especially since they are piggybacking on the sweetheart deal AM already gets from CHK (cherry picking the wells).  Chesapeake just did two $1.25 billion project finance deals (one in November and one this month)  with groups that included EIG.   EIG bought $500 million of preferred interests in the November deal; I can’t tell what EIG’s interest is in the latest deal, which is led by Blackstone.  Is it likely that the heightened scrutiny will force the board to cut off AM?  Was CHK getting favorable terms on their debt offerings because of the higher returns that some lenders were getting on the AM side deals? Assuming that EIG stops lending to McClendon, it seems that the disappearance of their sweetheart side deal might cause EIG to walk away from future direct-to-Chesapeake financings.  Does anyone think this poses a serious problem for the company (ie,. that they will be frozen out of the high yield debt market)?  Is it likely that CHK will have to  do an equity raise (or rights offering) in the near future?  This has been a battleground stock on VIC and I would love to read any thoughts on how this will play out.

    SubjectRE: RE: RE: Oh dear
    Entry04/18/2012 02:25 PM
    Membertyler939
    page 7
     

    SubjectRE: RE: Oh dear
    Entry04/18/2012 10:13 PM
    Membersugar
    EIG only got an ok deal. I just did a deal like this, except focused on the very best part of the liquids rich Marcellus in West Virginia, and with way better terms - a 25% preferred return and then 50% revenue split.
     
    Oh, and Gale Force is an investor in the deal (mine, not EIG's).

    SubjectRE: RE: RE: Oh dear
    Entry04/18/2012 10:57 PM
    Membersugar
    And to be clear, wasn't trying to brag, just saying this is all being blown way out of proportion.
     
    If CHK was a normal E&P company and not a land speculation company, I think their deal with Aubrey would be totally fair. If companies like GMXR, XCO etc had deals like that with their management, they would likely not have gotten into trouble in the way they did. It is a clever way to align management with shareholders.

    SubjectRE: RE: RE: RE: Oh dear
    Entry04/19/2012 08:49 PM
    Memberjso1123
    sugar - i beg to differ on the alignment question.  The founders well program (FWP) is a flawed program and the board is wrong in stating that it aligns AM w/shareholders.  Here's why:
     
    1) AM doesn't participate in 2.5% of all capex that CHK spends.  He just participates in 2.5% of the wells they drill.  Therefore his incentive is to spend lots of money accumulating large land positions on the shareholder's nickel with the hope of landing in the "core" of a play.  He then drills the core aggressively and gets to put 2.5% all of that in his private oil company.  He only compensates CHK for 2.5% of the acreage he drills - not 2.5% of all the acreage that CHK overpaid for in an effort to find the part they are ultimately drilling.  And the beautiful part is that he gets to buy that acreage below market b/c the core of these plays can be worth $15-$30k/acre but on avg CHK will pay much less than that when their landmen go into new plays and blanket them with dollars.  This explains the frenentic land buying behavior of the company and the fact that CHK has the lowest ROEs/ROICs in the industry
     
    2)  When I think about the structure of his financing that Reuters disclosed, it's even worse - AM doesn't even fund 2.5% of the wells.  Someone else does (EIG) and AM only gets paid if what he puts in there is highly economic and can clear the very high preferred rate these guys are taking.  So its very asymmetric and creates even more incentive to gamble and drive hard to get the best assets in there.  This gets back to point #1 - his incentive is to destroy lots of value to lock up good assets, and then drill the good stufff w/high ROICs so his personal oil company gets loaded up with all the gravy and CHK shareholders are left holding the bag.  It's a very screwed up structure if you ask me. 
     
    Lastly how can this board claim that aubrey's PA has no bearing on the company?  They had to bail him out in 2008 for the same thing!  (and it cost the company dearly - $75mm bonus to keep him liquid, $12mm to buy his map collection, and hard to quantify multiple compression for all the heat they took in the press and w/their shareholders).
     
    Anyone know mason hawkins at southeastern?  he has been one of Aubrey's longest supporters, would be curious to hear why he thinks this incentive structure makes sense. 

    Subjectproduction cuts
    Entry04/21/2012 04:03 PM
    Memberbruno677
    anyone have any insights on why e&p buys are not curtailing production - i though more companies would cut production and if they are hedged close their hedges in the public markets 
     
    i have seen this behavior in natural gas buyers in time to spikes - fertilizer guys would shut production and close hedges.  But the e&p guys keep producing in a $2 gas world.
     
     
     
     

    SubjectRE: RE: RE: RE: RE: RE: Oh dear
    Entry04/22/2012 11:12 PM
    Memberjso1123

    sugar - This earlier post details the acreage spend over time which I think addresses the question.  As it relates to you your second question, I'm almost positive he does - and it's one more incentive to conduct the business the way the company does.

     

    SubjectRE: RE: RE: RE: RE: RE: RE: RE: Oh dear
    Entry04/23/2012 11:17 AM
    Memberjso1123
    sorry, link should have gotten you to comment 47 i think (from jaxson905), goes through capex.
     
    I guess I don't think it's fine when you consider how it's structured - let's say the company leases 1.0mm acres at $3k/acre = $3.0b land investment in an emerging shale play.  Aubrey pays none of that (all paid by shareholders).  He is able to capture this big commanding position in short order b/c he is paying big prices (CHK has done this in almost every shale play they have entered btw, we've heard this very consistently from industry contacts).
     
    He then identifies a core area of say 150k acres (15% of the land position), with most of the remaining land being marginal.  They aggressively drill this and Aubrey gets to buy in at $4k/acre (CHK's basis) under the FWP b/c he only has to buy in when they start drilling. 
     
    Ultimately CHK monetizes this "core" area at $15-20k/acre in one of these JV deals.  Voila, Aubrey makes 4x his money in the sale (bought for $4k, sold for $15-20k).  CHK shareholders?  They paid $3.0b / 150k acres = $20k/acre.  They are lucky to get their money back.  This is why CHK ROICs are the lowest in the industry. All these deals make no money for shareholders, but they make a lot for the CEO.
     
    Incentives aren't aligned here at all.  If he paid 2.5% of ALL CAPEX (including all acreage, G&G, etc) then that would be fully alignment. 
     
    In regards to EIG deal, I would argue it seems pretty juicy.  6% cash pay plus 3% PIK = 9% return before the override of 3.75% on all the wells (free and clear of capex/op costs).  Pencils out probably to mid-to-high IRR and it was done on one of CHK's most economic plays (high liquids content), and these guys have a first lien claim on the asset (good collateral coverage). 

    SubjectRE: Board terminates FWPP
    Entry04/26/2012 09:15 AM
    Membertyler939
    It seems to me this is inviting an activist battle.  I don't think this is too littlle, too late.  

    SubjectRE: RE: RE: Decent chance Aubrey is insolvent
    Entry04/26/2012 01:11 PM
    Membertyler939
    won't the board just give him a ton of money/shares to compensate him for ending the FWPP early?
     

    SubjectSoutheastern
    Entry05/01/2012 09:23 AM
    Membertyler939
    I am amazed that they are satisfied with this.  I guess when you own 87 million shares and have put up with this crap for so long, any improvement is enough.

    SubjectRE: RE: Keeps getting better
    Entry05/02/2012 12:07 PM
    Memberflow123
    sugar -- the likelihood of activists or new management seems to increase with these revelations.  But wouldn't there also be an increased probability that more dirty laundry gets aired as the spotlight is shown on McClendon's side shows and the BOD's rubber-stamping?  As they say, there is never just one cockroach in the kitchen.
     
    A buy at this point remains as speculative as ever.  I would not be surprised to to see more problems uncovered.

    SubjectAubrey's Days Numbered?
    Entry05/02/2012 02:13 PM
    Memberbruno677
    Looks like CHK is setting up for an activist investor or at least some serious agitation from existing institutional investors.
     
    Aubrey's days of using the company as a private piggy bank are over. 
     
    Would it not be more efficient to sell the whole company to a major that sell assets piece by piece  
     
     

    SubjectRE: Aubrey's Days Numbered?
    Entry05/02/2012 02:47 PM
    MemberGideonMagnus
    There's the valid question of whether or not CHK is better off without him. Now that he's off the board, if the BOD is faced with firing him, would they sell the company instead?
     
    CHK is looking like a classic example of a "cheap, but not safe" value play. There's a reason the market has this valued at well below it's theoretical liquidation value.

    SubjectRE: RE: Aubrey's Days Numbered?
    Entry05/02/2012 03:11 PM
    Memberbruno677
    Southeastern Asset Management - largest shareholder in CHK switched to a 13(d)
     
    If I was the BOD and after letting Aubrey destory value - the best exit might be a sale of the company. 
     
    The asset base of CHK should interest most majors. 

    SubjectRE: RE: RE: Aubrey's Days Numbered?
    Entry05/02/2012 05:15 PM
    Memberutah1009
    I think that was Aubrey's last conference call with CHK. I bet he's either fired or resigns by the end of the quarter. I hope his personal attorneys are better than the ones advising CHK and signing off on all this stuff. Actually, I dont.
     
    I've been running through my nav and I'm still not sure it's cheap enough. The valuation ranges on their plays are SO WIDE because their disclosure is so bad and it's debatable how much of the capex deficit (a giant number) should be counted as a liability. A lot of their plays are pure junk, like Niobrara and Eagle Ford and Bakken. Are there more foolish foreign buyers after seeing how awful most of their JV's have been? Does anyone know what would happen to the subs like CHK-Utica in a bankruptcy? Are those preferreds cross collateralized? I'm going through their assets in more detail, will try to post something soon. 
     
    Aubrey made a comment today that succinctly describes everything that's wrong with the entire e&p industry: "The alternative of sitting there and doing nothing and just waiting for gas prices to recover, I know that's a losing strategy." Folks, there you have it, EVERYTHING you ever wanted to know about why this industry is so dysfunctional is there in that flawed belief. It's akin to the fund manager who believes it's foolish to hold cash. Does Aubrey even attempt to rationalize this to investors? No. 
     
    I think board members are probably panicking. You better believe that the words "personal liability" have been used by CHK counsel. Stripping Aubrey of the chairman title was probably just an intermediate step to firing him...buy some time if nothing else. The hedge fund simply HAS to be the last straw. 

    SubjectRE: RE: RE: RE: Aubrey's Days Numbered?
    Entry05/02/2012 05:34 PM
    MemberGideonMagnus
    I was wondering if the 4.5% convertible preferred (CHK-D) might be a decent play for the potentially reduced downside risk if one wanted to bet on the company's survival first and upside second. But at a price of 77, the current yield is only 6% and the option is way out of the money. So if the company survives but doesn't thrive, you've got a 6% yield on a higher risk company, which is unattractive. If CHK is bought by a better credit, you should get a price jump, but the call option probably isn't worth as much in a bigger company. If CHK recovers reasonably well on it's own, it's still a long way to go before the call option has value. So I think I'll let this one pass for now and wait for a few more shoes to drop.

    SubjectRE: RE: RE: RE: Aubrey's Days Numbered?
    Entry05/02/2012 05:38 PM
    Memberbruno677
    I agree - I dont think we get to see Aubrey on another CHK call
     
    12 bil. of debt, 12 bil. equity market cap, 10-12 bil. of asset sales and $10-12 bil. of cap ex
     
    if someone can get their hands around controlling capex and the balance sheet - ther underlying assets could be worth something
     
    might be an interesting entry for a major

    SubjectRE: RE: RE: RE: RE: Aubrey's Days Numbered?
    Entry05/02/2012 06:49 PM
    Memberjso1123
    The company isn't saleable - he's put everything in these convoluted JV structures and it's unwieldy to a major (the only potential buyers).  On top of that, consider this:  BP spent $5.0 billion in capex this quarter and they are producing 3.5 million boe/d.  CHK spent $3.6 billion and they are producing 0.6 million boe/d!  As any of you know who have followed the majors, all they care about is ROIC b/c that drives their multiple - CHK has the lowest ROIC/ROE of the group.
     
    bruno i think your math doesn't take into account the massive off balance sheet liabilities this company has - the amount to at least $9 billion based on what can be readily identified.  Add to that $13.5b of net debt and $4.5 billion of preferred and you get total liabilities of close to $27 billion.  EV is ~$38 billion today.
     
     

    SubjectRE: RE: RE: Delaying 10Q
    Entry05/11/2012 04:40 PM
    Memberflow123
    Have a look at this gem from the Q:
     
    As part of our asset monetization planning and capital expenditure budgeting process, we closely monitor the resulting effects on the amounts and timing of our sources and uses of funds, particularly as they affect our ability to maintain compliance with the financial covenants of our corporate revolving bank credit facility. While asset monetizations enhance our liquidity, sales of producing natural gas and oil properties adversely affect the amount of cash flow we generate and reduce the amount and value of collateral available to secure our obligations, both of which are exacerbated by low natural gas prices. Thus the assets we select and schedule for monetization, our budgeted capital expenditures and our commodity price forecasts are carefully considered as we project our future ability to comply with the requirements of our corporate credit facility. As a result, we may delay one or more of our currently planned asset monetizations, or select other assets for monetization, in order to maintain our compliance. Continued compliance, however, is subject to all the risks that may impact our business strategy.



    SubjectRE: RE: RE: RE: Loan and conference call
    Entry05/14/2012 12:44 PM
    Membertyler939
    I agree on the stock rallying if Aubrey is given the boot, which begs the question why didn't Icahn or Southeatern demand it.  My worry (if I was long) would be that Aubrey gets to keep his position for going along with whatever else Icahn or Longleaf wants, and I have no idea what to do with the stock if that is the case.  I think trying to figure out the knockon effects of what CHK is going through maybe the more lucrative trade.

    SubjectRE: RE: RE: RE: motivation for CHK capex
    Entry05/15/2012 03:28 PM
    Memberjso1123
    Teton - i have similar numbers - ~$1.3b of interest on debt/preferred.  I think they are going to have to cut the common dividend to $0 shortly. 
     
    EBITDA is $3.3b this year (consensus).  Note they are capitalizing ~$400mm of G&A last year which is way too high relative to comps - if we say $250mm of that is inappropriate, pro forma EBITDA is more like $3.0-$3.1b.  That leaves them $1.7b in cash flow that can be applied to capex if this company was to consider drilling within cash flow.  However D&A is ~$2.0b, so it isn't enough to even replace reserves and historical (understated) F&D. 
     
     

    SubjectRE: chk
    Entry06/01/2012 05:47 PM
    Memberjso1123
    I think the bigger question is why the CEO of one of the largest US gas producers finds it necessary or useful to put out a press release announcing an 8 day flow rate on 1 well.  Smacks of desperation.
     
     

    SubjectRE: RE: RE: RE: RE: chk
    Entry06/01/2012 07:54 PM
    Memberjso1123

    $2.5b in EBITDA and $1.5b in interest expense.  Stock is trading at 14x EV/EBITDA right now when stocks EOG/APC etc are at 5x.  It's a mess.  They are going to have to sell the crown jewels to raise $10b in cash and then what's left? 

    Separately will you energy mavens take a look at my LNG math (posted on LNG idea) and let me know why the stock isn't going up?
     
     

    SubjectRE: RE: chk
    Entry06/08/2012 11:03 AM
    Memberwright13
    It doesn't appear that they are giving up a huge amount of earnings from these assets. The midstream business was projected to earn $75 million in 2012 (it earned $123 mln in 2011). Assuming that they are getting $2 billion for the consolidated midstream assets, GIP is paying a decent multiple for this business. This line of thinking assumes a couple of things:
     
    1) CHK was properly allocating revenue and costs to its internal midstream business
    2) They worked out a deal with GIP so that they won't see a massive rate increase from what the E&P business is currently paying CHK midstream
     
    If the above is true, you could argue that CHK has better uses for capital than 3-6% FCF yield (not to mention the money they were going to invest in the business going forward).

    SubjectRE: RE: RE: chk
    Entry06/08/2012 12:47 PM
    Memberjso1123
    I listened to the CHKM call.  In classic chesapeake form, they only tell you the good news without telling you the bad news (b/c they aren't disclosing the financial impact):
     
    1) LP/GP stake in CHKM:  they are buying this for market ($2.0b vs. $1.75b trading value of CHK's 46% LP stake)
     
    2) CMD and mid-con assets:  they've agreed to a $2.0b price but they aren't disclosing the EBITDA associated with these assets or the incremental cost to gathering they will have to bear by losing the vertical integration.  You can't look at the $75mm of marketing/gathering/compression net margin they guide b/c that is a mix of all kinds of businesses.  Ultimately the financial impact depends on what kind of gathering cost arrangement they agree to with GIP, and for now they aren't disclosing that. 
     
     
     
     

    SubjectRE: RE: RE: RE: chk
    Entry06/08/2012 01:16 PM
    Memberwright13
    Ok - so let's assume then that they are selling the CMD and mid-con assets @ market for MLPs. The Alerian index is yielding 6%, the big mainstays (EPD, Magellan, Plains) are at around 5%.
     
    At $85  WTI, a Permian well yields ~30% cash on cash return over the life of the well. An Eagle Ford well is arguably better (NGL exposure skews this). It still doesn't make sense for them to continue to invest in this business given a) their cash crunch and b) the opportunity set in front of them. 
     
    I don't really want to play cheerleader for this company, but I do think it is a good sign that they are shedding these assets so that they can direct capital to better places. You could make the argument the midstream business provides volatilty protection vs. their E&P business, but I think we can agree that the market wasn't going to give this company credit for that given their current situation.

    SubjectRE: RE: RE: RE: RE: chk
    Entry06/08/2012 02:22 PM
    Memberjso1123
    It's just creating more off balance sheet leverage at the end of the day.
     
    Every large E&P has gathering/processing/midstream assets (DVN has ~$500mm in op income from theirs).  Most like to stay vertically integrated b/c you can retain operational flexibility.  Gathering/processing assets are notoriously volatile in nat gas b/c when prices fall you need to stop drilling if you want to preserve value, but in order to stop drilling you can't have take-or-pay midstream commitments. 
     
    MLPs/midstream companies of course all know how volatile the underlying volumes are with G&P assets, so they only build them for you if you sign take-or-pay/fixed price commitments.  Most companies don't want to do this b/c it forces them to drill in bad commodity price environments (and destroy value).  CHK has openly done this and just did more of it today.  Like all these things, selling them comes w/a cost.  These aren't regulated pipelines and I don't think MLPs build them for E&Ps assuming 5% IRRs. 
     
    CHK has $23b of net debt & prefs and a $38b EV and at $2.50 gas generates $2.4b of EBITDA.  EV/EBITDA = 16x, net debt/EBITDA = 9x.  That compares to most other large E&Ps in the 4-6x EV/EBITDA range.  Just not sure how this works. 
     
     
     

    SubjectRE: Permian
    Entry06/11/2012 11:36 AM
    Memberjso1123
    CHK guiding to $6-7b.  OXY said to have offered $3.5b.  CXO comp (recent deal) would imply $3-4b. 
     
    Big point of debate is the 1.5mm acres CHK says it has.  Problem is that ~1/2 of that is in the old Delaware Basin gas play from 2007 (Culberson County deep barnett stuff that never panned out).  You can see that if you look at CHK's 2007 analyst day where they show the acreage.  Unfortunately you won't be able to find that b/c CHK never shows you any old presentations, just their most recent version of history (the one presentation available on their website).  I was able to track it down. 
     
    So the acreage they have in the Permian oil plays (really just the Delaware Basin side, have very little in the Midland Basin side) is ~700-800k acres.  They added a bunch in the last year (# was 450-500k in 2010 analyst meeting, increased to 700-800k in advance of the sale). 
     
     

    SubjectRE: RE: Permian
    Entry06/13/2012 10:56 AM
    Memberncs590

    You can look at what Concho bought from Three Rivers on slide 6 here:

    http://media.corporate-ir.net/media_files/IROL/21/211775/CXO%20Acquisition%20Investor%20Presentation.pdf 

    they got 58 MMboe of proved reserved (50% oil, 55% PD), 7 Mboe/d of net production, and a total of 200,000 net acres (a lot of the acreage is outside of the Delaware basin and midland basins proper) The acquisition price was $1 billion cash.  The 7Mboe/d of production (which I assume is also 50% oil) should probably be valued at $50k per daily boe.  Backing out this amount ($350 million) values the remaining acreage and reserves at $3,250 per acre of $11.20 per Boe of proved reserves. 

    Concho itself has 400 MMBoe in proved reserves and 543,509 net acres (a decent amount of which is in the yeso/lower abo north of the Delaware Basin).  Concho has an enterprise value of roughly $11.5 billion (121,000 acres are in the wolfberry, and 273k are in the Delaware basin – a total of 394k net acres or 72% of their acreage.  I believe this is analogous to CHK’s 835k net acreage number from last October).  CXO’s production is 60% oil, which is better than both the Three River’s acquisition, and the assumed 50/50 mix for CHK acreage.  CXO has daily production of 73 MBoe/day.  Valuing CXO’s production at $60k per flowing barrel ($4.4 billion) leaves $7.1 billion in enterprise value ascribed to acreage and reserves for a value of $13k per acre or $17.75 per Boe of proved reserves. 

    CHK has said that 5% of their reserves and production are in the Permian.  CHK has total production of roughly 593 Mboe/day and 3,333 Mboe of proved reserves.  5% of this is 29.7 Mboe/d and 167 Mboe of proved reserves.  CHK has 1,5 million acres in the play (of which 835k net acres are in the Delaware and Midland Basins). 

    Using the metrics of the Three Rivers deal suggests $4.875 billion for the acreage (or $1,866 for the reserves) and $1.5 billion for the production (@$50k per Boe/day).  This suggests a value of $3,366-6,375 depending on whether one uses acreage or reserves.  Averaging the two yields a value of $4.9 billion

    Using the CXO metrics (but still valuing CHK’s production at only $1.5 billion and only looking at their Midland and Delaware basin acreage position of 835k net acres) suggests a value for the acreage of $10.9 billion (or $3 billion for the reserves).  This suggests a total value of $4.5-12.4 billion, or an average of $8.5 billion

    OXY reportedly offered $3.5 billion to buy the Permian.  This was a cash offer to a seller viewed as distressed, and it was largely sight unseen as the data room was not open yet.  I would think that a shrewd acquirer like OXY wouldn’t offer more than 60% of what they thought the value was in a situation like that, especially without good information on the asset.  This suggests OXY thinks the property is worth $5.8 billion.

    I think these crude metrics somewhat validate CHK’s guidance for the sale as well as my own expectation for a price around $5 billion.


    SubjectRE: RE: RE: Permian
    Entry06/13/2012 12:49 PM
    MemberBiffins
    Except that both CXO's purchase and OXY's rumored bid were made in $100-105 WTI environment, not 80-85ish. And the prices are still sliding with bad macro data piling up. It's a big difference. 

    SubjectQ2 update
    Entry08/07/2012 08:30 PM
    Memberncs590
    It looks like CHK will be getting $4-5 billion for the Permian (three sales out of four should close in the next month).  More importantly:
     

    It looks like Chesapeake is getting serious about transitioning from “resource capture” to “resource development” mode, and with the new board of directors I think this is credible. 

     

    They have lowered their 2013 rig-count to 100 from the originally projected 200 (and recent guidance of 131), and will be either selling or giving up on acreage they can’t HBP.  They are focused on their 10 core plays and will have a highly contiguous landholding in the core of each that is held by production, with infrastructure, midstream, gathering and take-away capacity built-out for decades of low-cost development.  I believe the increase in capex this year (partially due to in-fill land acquisition and partially due to drilling and infrastructure) is meant to largely complete this transition. 

     

    Since the last guidance in Q1, they have raised 2012 capex by $500 million and lowered 2013 capex by $750 million, while actually increasing 2013 production.  Consensus earnings per share for 2013 and 2014 are $1.45 and $2.36, which take into account the low strip price and the current glut of NGLs.   While the current valuation looks compelling on an earnings basis, the real value is in the asset base they have built and the years of low-cost production growth to come.

     

    I don’t believe the current board of directors is done here.  The patient has been stabilized, but now it is time to get at the value.  Once they have completed the $7 billion of asset sales in Q3 - which could be within a month - I believe the focus will shift towards maximizing the share price.  I believe Icahn and Southeastern (who now control the board) will not be content to watch natural gas prices and earnings slowly rise for the foreseeable future.  Some options available to them:

     

    1)      Further Capex Cuts:  While the planned levels of activity for 2013 are probably what is necessary to avoid any pipeline penalties or loss of expiration of core acreage, the board could decide it is worth the penalty.   Alternatively, they could credibly lower capex for 2014 and beyond, which would illuminate substantial FCF.  Maintenance capex is probably about half of the $6 billion they will spend on wells next year

    2)      Further Asset Sales:  Chesapeake has essentially built 10 long-term hydrocarbon factories in their core areas.  If the market only wants to give them credit for their current production and earnings, they could sell substantial portions of these assets to others without hurting their earnings power.

    3)      Dismantle the company: the market gives much higher valuations to pure-play companies.  Chesapeake’s Marcellus asset would be worth more than $12 billion at the valuation of Range Resources, and their current Eagle Ford position is worth $9 billion.  No analyst I have seen disputes what the sum of the parts would be worth, and the new board members are experienced at monetizing assets

    4)      Sell the company: The XTO and HK acquisitions prove that the majors are willing to pay-up for these long-lived assets.  These assets are worth considerably more to a company with a low cost of capital (think PV8 vs. PV15) and the majors are struggling to replace their reserves and grow production.  Compared to the alternatives (building oil-sands production, deep-water offshore, dealing with the Russians/Venezuelans etc.) this company would be cheap at double the current valuation. 


    I think this investment has been substantially de-risked and trades at a very attractive valuation. There will certainly be more details to come over the next few months, but I think they are over the hump. 


    SubjectRE: Q2 update
    Entry08/07/2012 09:35 PM
    Memberjso1123
    NCS,
    Tell me if you think I have any of these numbers wrong:
    Their guidance is for $3.0b of EBITDA (at $3 gas and $90 oil)
    Their interest expense annualized on current debt loan is $1.5b. 
    Net debt/prefs at 6/30 totals $22b.  When you add negative working capital (from CHK investor presentation) the figure rises to $26b.  That puts leverage at 8.5x EBITDA.  This excludes any off balance sheet liabilities (VPPs, royalty interests, negative NPV midstream commitments, etc). 
    So they have $1.5b of EBITDA - interest to fund capex.  Their current capex is $12b (ex-interest).
    If you think maintenance capex is $3b, they still can't fund that within cash flow. 
     
    Why did they raise capex by +$1.0b (+$0.5b for drilling, +$0.4b for acreage, +$0.1b for capitalized interest)?  They just did a rescue loan at 11%.  Shouldn't they be cutting capex?  This is the third quarter in a row they have raised it (Q4, Q1, now Q2).  My guess is they simply can't get out of their capex commitments given how mortgaged this company is. 
     
    In Q2 they sold $3b in assets yet net debt went up (+$0.6b). 
     
    I just don't see how any of this makes sense.  The company was built for an up and to the right commodity market but if that is over it is going to be extraordinarily difficult for them to deleverage this without it being dilutive to equity. 
     
    Just a few thoughts.
     
     
     
     

    SubjectRE: RE: Q2 update
    Entry08/07/2012 10:11 PM
    Memberncs590
    HI JSO,
     
    I believe this year is not indicative of the future. The company spent way too much money to grow their oil production, acquire leasehold, and drill just about everything they could get their hands on.  I do not dispute that this year has been an absolute mess and disaster, my point is that it is almost over and Aubrey isn't in charge anymore.
     
    There is a new Chairman and board of directors that is extremely credible.  They have cut the planned 2013 rig-count in half, and already lowered capex for next year twice.  For this reason, I think it is worth looking at 2013 and beyond.
     
    As of 6/30, net debt is $13.9 billion.  Adding the convertible preferred shares takes this to a little under $17 billion.  Adding in the non-recourse asset-level preferrreds takes it to $19.4 billion.  Negative working capital and other long-term liabilities takes this number up to $22.6 billion.   
     
    I'm not sure how you are getting a number that is $3.4 billion higher than mine, even if you assume an incremental spend of $1 billion since the quarter.  There is no off-balance sheet liability for VPPs or royalty interests (the asset and liability have both been taken off the balance sheet).  I believe negative NPV midstream committments are already accounted for in their cost structure.
     
    I think you are correct that there were HBP, JV, pipeline and other commitments that convince the BOD to raise capex this year so that they could permanently lower it going forward.
     
    Right now they have ~$1.5 billion in interest costs on $15 billion of net debt.  They will have EBITDA this year of roughly $3.2 billion (now hedged for 64% of gas @ $3.00 for the rest of the year). 
     
    Next year they will have ~$1 billion of interest cost on $10 billion of net debt.  Ebitda for next year at the strip should be $4.25 billion or so (substantially lowered by the crash in NGL prices).  The natural gas strip rises from there . . .
     
    Do you think the new Board is not credible, the new guidance is not credible, or that they won't get the asset sales done this quarter? 
     
    I don't disagree about the mess they have gotten themselves in, but I really think they are at a turning point now with Icahn/Dunham/Hawkins calling the shots.  Do you think their survival is in doubt or that they won't be able to repay the "goldman loan" this year?
     
    Thanks,

    NCS

    SubjectRE: RE: RE: RE: Q2 update
    Entry08/08/2012 12:22 AM
    Memberncs590
    Hi Teton, 
     
    I stopped responding to every post because a lot of people seemed convinced the company was going to go bankrupt and they did believe any of my assertions that they would not, or want to discuss the valuation.  I provided some metrics for the Permian sale in June to try to handicap that as best I could.
     
    Now that it looks like they will soon be out of the woods. I thought it was an appropriate time to revisit the idea.  A lot of people really get their vitriol up about Aubrey and the funding issues.  If you still think these two are a major problem and a reason to avoid this investment outright, I would be interested to hear why - especially if you think it is worth shorting.  If not I would love to hear what you think it's worth if you have done more work on it.
     
    Thanks,
     
    Ncs 

    SubjectRE: RE: RE: RE: RE: Q2 update
    Entry08/08/2012 07:17 AM
    MemberBiffins
    Keep reading how Aubrey is not in charge anymore. I thought I must have missed some news announcements. Went to their site to be sure and............. lo and behold he's still the CEO
     

    SubjectRE: RE: RE: RE: Q2 update
    Entry08/08/2012 09:53 AM
    Memberjso1123
    ncs - we're actually not far off.  I'm at $21b of net debt before negative W/C and you're at $19.5b.  The difference is ~$1b in convertible debt (CHK books a portion of this as equity so they mark it below par in their reporting) and $0.5b for the granite wash royalty trust (i add to asset level preferreds/NCI).  Negative W/C was -$3.7b at Q1.  That gets to $24-25b
     
    I'd be very cautious taking 2013+ #s from these guys to the bank.  Every year since I started following these guys, the pattern is the same - capex for this year grows and grows throughout the year but they always show you this big payoff just around the corner in the forward 2 years (when capex will fall and production will rise and there will be FCF).  Then as the year advances, the asset mix shifts, they do a bunch of asset sales, then reforecast and alas you are back to huge capex and negative FCF.  But don't worry, just wait a year or two they say and you'll see capex come down.
     
    Go back to Q1 2011 and look at their capex forecast for 2012, then follow its progression by quarter.
     
    That's why I always focus on current year w/CHK.  That is the only real number they can't aggressively fudge.
     

    SubjectRE: RE: RE: RE: RE: Q2 update
    Entry08/08/2012 10:08 AM
    Memberncs590
    thanks for the response jso,
     
    I'll look into the convertible debt, although I'm not sure it should be marked at par if it is long term 2% debt.
     
    CHK has sold everythign in the royalty trust.  The portion of the trust they still own is an asset.  there is no liability.
     
    I have followed the company for a long time as well and you are obviously quite correct with regard to the "wait a year or two" and inevitable capex raises.  Stop me if you've heard this one, but this time: it's different.
     
    Do you really see Icahn and the new board raising capex going forward for any reason?  They have all voacally said the company spends too much and that it needs to be reigned in.  They control the board.  Aubrey has been stripped of the chairmanship and will almost certainly be fired if the ongoing internal investigation into his conduct comes up with anything. 
     
    I think this is a different company than it was, and I don't think the market has caught on to that.  I am surprised by this, because any other time Icahn has effectively gotten control of a board the market seems to quickly understand that change is underway.
     
    ncs

    SubjectRE: RE: RE: RE: RE: RE: Q2 update
    Entry08/08/2012 10:22 AM
    Memberjso1123
    Yes but I guess what i'm saying is i'm sure the capex will come down b/c the new board but if it does they won't hit their #s they've laid out for the street.  This is a shark that has to keep swimming or it dies.  They have to be always turning acreage, buying and selling assets, moving the goal posts, b/c if they don't then it will become obvious that they are stuck b/c if they tried to drill w/in cash flow the company would shrink. 
     
    Take for example the acreage buys - they took their guidance from $1.6b to $2.0b this quarter.  Why in the world does this company need more acreage anywhere?  It just doesn't make any sense.  Obviously they have to do it.  I've read that the Marcellus, Barnett and other JVs require CHK to replace any expiring leasehold on its own dime.  THis is one more example of how this company was built for a perpetual bull market with off balance sheet liabilities we can't quantify.  Everyone is walking from acreage in the Barnett yet CHK is being forced to buy it.  And what kind of economics do yout hink the leaseholders are extracting given they know that CHK has a contractual obligation to re-up the lease? 
     
    Someone should have stepped into the company in 2007 to change it.  Now I fear it's too late.  The lights are on and the bill is due and the check is $25b (from what I can readily calculate alone) and after all this spending they have $3.0b in cash flow to show for it.  Maybe they have tons of assets producing no cash flow that have loads of value and they can monetize those.  I would argue the large E&P companies have the same (APA, DVN, APC, EOG) but difference is those guys all trading at 4-5x EV/EBITDA on 2012 despite having big midstream businesses, tons of acreage and resource in the same shale plays, etc etc etc. 
     
    On the Granite Wash royalty trust, it is definitely an obligation.  CHK has committed to drilling and the trust gets to skim royalties.  You absolutely need to add that to your debt # (as well as all the other arrangements like this, problem is we can't quantify the other ones). 

    SubjectRE: RE: RE: RE: RE: RE: RE: Q2 update
    Entry08/08/2012 11:01 AM
    Memberncs590
    jso,
     
    I agree that this company was built for a long-term bull market in hydrocarbons.  We both agree it doesn't look good at $3 gas.  I guess we will have to agree to disagree about what it looks like going forward.
     
    I believe tehy will hit the lowered cashflow guidance for 2013 as well as that they will only be spending $100 million per quarter for leasehold going forward.  Most of the leasehold spend this year is to fill in the gaps in their Utica and Anadarko positions, but going forward they will have minimal spending needs for gathering pipelines and small percels.  It sounds like you don't believe that they will stick to the cashflow guidance and hit their lower cashflow numbers at the same time.
     
    I don't believe they are doing any leasing in the barnett, and I don't believe the acreage maintenance commitments in their JV's is a big problem.  No one is going to force CHK to pay a high price for acreage if the acreage isn't worth much, and they usually go through third parties.
     
    You are correct on the costs for the Royalty trust, I missunderstood what you meant, but have included that minor obligation.
     
    I think the rise in capex this year is an effort to clean up a lot of these problems - i.e. drill to hold Eagleford and Utica acreage, get production up to levels proscribed in pipeline commitments etc.  I think they have taken care of it this year and will have dramatically lower costs going forward.  I believe the new board of directors is acting as you or I would if we owned the company.  If it is in fact, business as usual at CHK, I will be wrong.  Do you really think Icahn would let that happen though?
     
     
     
     

    SubjectAubrey stepping down
    Entry01/29/2013 06:20 PM
    Memberncs590
    I think we will see more sales and lower spending and debt when CHK reports in February.  I am in broad agreement with Icahn's statement on Aubrey's "retirement":

    "Aubrey has every right to be proud of the company he has built, the world class team of people at Chesapeake and the collection of assets he has assembled, which in my opinion, are the best portfolio of energy assets in the country. While it is known that some of these assets will be sold by the company in due course, I do not believe that this will in any way effect the ultimate realization of Chesapeake’s potential.

    I am confident that history will prove that Aubrey has been correct about the value of natural gas in general and the value of Chesapeake in particular."


    SubjectRE: Sinopec
    Entry02/25/2013 07:49 PM
    Memberjso1123
    If you look at what Sinopec paid, they are basically valuing undeveloped acreage for $500/acre (they bought 50% of 37,500 boe/d which is worth $50,000-60,000/daily boe).  To put that in context, the Stifel analyst had the undeveloped Miss Lime worth $5.5b in his NAV.  
     
    I think the theme of asset value deflation is accelerating in the E&P space - the bull market math of crazy $/acre valuation metrics just doesn't fly anymore.  This is very bad for an overleveraged player like CHK.

    SubjectRE: RE: RE: Sinopec
    Entry02/26/2013 11:30 AM
    Memberncs590
    The price is a dissapointment, but an expected one: CHK has been marketing this asset for a year and the entire world knows that they cannot develop the entire position on their own (at least not without levering back up).
     
    Based on year end gross production of 46 mboe/day, I calculate net production at year end of ~36 mboe/day.  This is high decline mid-con production and is 45% oil, 9% NGLs, and 46% gas.  I calculate the value of production as follows:
     
    High decline mid-con oil production: $70,000 per daily boe
    High decline mid-con NGL production: $25,000 per daily boe
    High decline mid-con dry gas production: $4,000 per daily boe
     
    This suggests a value per daily boe in the Miss Lime play of: $35,590 and a value for 50% of year end net production of (assuming the entire 36 mboe/day is in Oklahoma) of $640 million.
     
    Sinopec also recieves 50% of 850k net acres.  CHK has drilled ~270 horizontal wells on 160 acre spacing, so the amount of undrilled acreage is 807k nets acres.  Assuming CHK receives the entire $1.02 billion, this means Sinopec paid $362 million for 403.5k net acres, or ~$900 per net undrilled acre.

    I think the acreage is probably worth double or triple this amount, but CHK was a known forced seller and the Mississippi lime covers a huge area - so there is no reason that a player looking to enter the play would need to go through CHK.
     
    Based on these metrics (and valuing CHK's Kansas acreage at only $600 per acre) put a value on their remaining holdings in the play at $1.7 billion.  There may be additional value here for their saltwater disposal system, which I don't believe was included in the deal.
     
    The bottom line is that the Miss Lime is "crappy rock" (to use Tom Ward's words) and it is not a shale.  The "type curve" is ridiculous not because it is innacurate, but becuase these wells are not homogenous or predictable like shale wells.  You could just as easily make a type curve for "the average well in Texas".  
     
    I think there is a negative read through here for Sandridge (whose previous sales took place before the shine was off the rose in the Miss) and to a less extent for undeveloped acreage in general.  I don't think this sale is representative of a drop off in undeveloped shale acres, because they are a predictable and known quantity that have a much more concrete value.  As an example, I have heard from numerous sources that undrilled Haynesville acres are still being acquired, or at least bid, at $7,000 per acre.

    SubjectRE: RE: RE: RE: Sinopec
    Entry02/26/2013 11:32 AM
    Memberncs590
    I should add that I think Sinopec got the undrilled acreage for 50% off.  I think CHK's remaining holdings in the play are worth $2.75 billion

    Subjectreply to Biffins
    Entry02/26/2013 09:48 PM
    Memberncs590
    Hi Biffins,
     
    I value the Utica at $5.5 billion - clearly the crude story never worked out, although the economics of the play look pretty good.
     
    Ncs
     
     

    Subjectanyone still following this name?
    Entry07/06/2015 11:18 AM
    Memberspike945

    looks like Hedgeeye put out a research piece highlighting some of the pipeline issues.  

    insiders have bought in march in good size - although they haven't been the best timed purchasers in the past.  

     

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